Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs, 21089-21139 [2016-07926]

Download as PDF Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations [FR Doc. 2016–07925 Filed 4–6–16; 11:15 am] Executive Summary BILLING CODE 4510–29–C Purpose of Regulatory Action DEPARTMENT OF LABOR Employee Benefits Security Administration 29 CFR Part 2550 [Application Number D–11713] ZRIN 1210–ZA25 Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs Employee Benefits Security Administration (EBSA), U.S. Department of Labor. ACTION: Adoption of Class Exemption. AGENCY: This document contains an exemption from certain prohibited transactions provisions of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (the Code). The provisions at issue generally prohibit fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs) from purchasing and selling investments when the fiduciaries are acting on behalf of their own accounts (principal transactions). The exemption permits principal transactions and riskless principal transactions in certain investments between a plan, plan participant or beneficiary account, or an IRA, and a fiduciary that provides investment advice to the plan or IRA, under conditions to safeguard the interests of these investors. The exemption affects participants and beneficiaries of plans, IRA owners, and fiduciaries with respect to such plans and IRAs. DATES: Issuance date: This exemption is issued June 7, 2016. Applicability date: This exemption is applicable to transactions occurring on or after April 10, 2017. See Section F of this preamble, Applicability Date and Transition Rules in this preamble, for further information. FOR FURTHER INFORMATION CONTACT: Brian Shiker, Office of Exemption Determinations, Employee Benefits Security Administration, U.S. Department of Labor (202) 693–8824 (not a toll-free number). SUPPLEMENTARY INFORMATION: mstockstill on DSK4VPTVN1PROD with RULES3 SUMMARY: VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 The Department grants this exemption in connection with its publication today, elsewhere in this issue of the Federal Register, of a final regulation defining who is a ‘‘fiduciary’’ of an employee benefit plan under ERISA as a result of giving investment advice to a plan or its participants or beneficiaries (Regulation). The Regulation also applies to the definition of a ‘‘fiduciary’’ of a plan (including an IRA) under the Code. The Regulation amends a prior regulation, dating to 1975, specifying when a person is a ‘‘fiduciary’’ under ERISA and the Code by reason of the provision of investment advice for a fee or other compensation regarding assets of a plan or IRA. The Regulation takes into account the advent of 401(k) plans and IRAs, the dramatic increase in rollovers, and other developments that have transformed the retirement plan landscape and the associated investment market over the four decades since the existing regulation was issued. In light of the extensive changes in retirement investment practices and relationships, the Regulation updates existing rules to distinguish more appropriately between the sorts of advice relationships that should be treated as fiduciary in nature and those that should not. This exemption allows investment advice fiduciaries to engage in purchases and sales of certain investments out of their inventory (i.e., engage in principal transactions) with plans, participant or beneficiary accounts, and IRAs, under conditions designed to safeguard the interests of these investors. In the absence of an exemption, these transactions would be prohibited under ERISA and the Code. In this regard, ERISA and the Code generally prohibit fiduciaries with respect to plans and IRAs from purchasing or selling any property to plans, participant or beneficiary accounts, or IRAs. Fiduciaries also may not engage in self-dealing or, under ERISA, act in any transaction involving the plan on behalf of a party whose interests are adverse to the interests of the plan or the interests of its participants and beneficiaries. When a fiduciary purchases or sells an investment in a principal transaction or riskless principal transaction, it violates these prohibitions. ERISA section 408(a) specifically authorizes the Secretary of Labor to grant administrative exemptions from ERISA’s prohibited transaction PO 00000 Frm 00145 Fmt 4701 Sfmt 4700 21089 provisions.1 Regulations at 29 CFR 2570.30 to 2570.52 describe the procedures for applying for an administrative exemption. In granting this exemption, the Department has determined that the exemption is administratively feasible, in the interests of plans and their participants and beneficiaries and IRA owners, and protective of the rights of participants and beneficiaries of plans and IRA owners. Summary of the Major Provisions The exemption allows an individual investment advice fiduciary (an Adviser) 2 and the firm that employs or otherwise contracts with the Adviser (a Financial Institution) to engage in principal transactions and riskless principal transactions involving certain investments, with plans, participant and beneficiary accounts, and IRAs. The exemption limits the type of investments that may be purchased or sold and contains conditions which the 1 Code section 4975(c)(2) authorizes the Secretary of the Treasury to grant exemptions from the parallel prohibited transaction provisions of the Code. Reorganization Plan No. 4 of 1978 (5 U.S.C. app. at 214 (2000)) (Reorganization Plan) generally transferred the authority of the Secretary of the Treasury to grant administrative exemptions under Code section 4975 to the Secretary of Labor. To rationalize the administration and interpretation of dual provisions under ERISA and the Code, the Reorganization Plan divided the interpretive and rulemaking authority for these provisions between the Secretaries of Labor and of the Treasury, so that, in general, the agency with responsibility for a given provision of Title I of ERISA would also have responsibility for the corresponding provision in the Code. Among the sections transferred to the Department were the prohibited transaction provisions and the definition of a fiduciary in both Title I of ERISA and in the Code. ERISA’s prohibited transaction rules, 29 U.S.C. 1106–1108, apply to ERISA-covered plans, and the Code’s corresponding prohibited transaction rules, 26 U.S.C. 4975(c), apply both to ERISA-covered pension plans that are tax-qualified pension plans, as well as other tax-advantaged arrangements, such as IRAs, that are not subject to the fiduciary responsibility and prohibited transaction rules in ERISA. Specifically, section 102(a) of the Reorganization Plan provides the Department of Labor with ‘‘all authority’’ for ’’regulations, rulings, opinions, and exemptions under section 4975 [of the Code]’’ subject to certain exceptions not relevant here. Reorganization Plan section 102. In President Carter’s message to Congress regarding the Reorganization Plan, he made explicitly clear that as a result of the plan, ‘‘Labor will have statutory authority for fiduciary obligations. . . . Labor will be responsible for overseeing fiduciary conduct under these provisions.’’ Reorganization Plan, Message of the President. This exemption provides relief from the indicated prohibited transaction provisions of both ERISA and the Code. 2 By using the term ‘‘Adviser,’’ the Department does not intend to limit the exemption to investment advisers registered under the Investment Advisers Act of 1940 or under state law. As explained herein, an Adviser must be an investment advice fiduciary of a plan or IRA who is an employee, independent contractor, agent, or registered representative of a registered investment adviser, bank, or registered broker-dealer. E:\FR\FM\08APR3.SGM 08APR3 21090 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 Adviser and Financial Institution must satisfy in order to rely on the exemption. To safeguard the interests of plans, participants and beneficiaries, and IRA owners, the exemption requires Financial Institutions to give the appropriate fiduciary of the plan or IRA owner a written statement in which the Financial Institution acknowledges its fiduciary status and that of its Advisers. The Financial Institution and Adviser must adhere to enforceable standards of fiduciary conduct and fair dealing when providing investment advice regarding the transaction to Retirement Investors. In the case of IRAs and non-ERISA plans, the exemption requires that these standards be set forth in an enforceable contract with the Retirement Investor. Under the exemption’s terms, Financial Institutions are not required to enter into a contract with ERISA plan investors, but they are obligated to acknowledge fiduciary status in writing, and adhere to these same standards of fiduciary conduct, which the investors can effectively enforce pursuant to section 502(a)(2) and (3) of ERISA. Under this standards-based approach, the Adviser and Financial Institution must give prudent advice that is in the customer’s Best Interest, avoid misleading statements, and seek to obtain the best execution reasonably available under the circumstances with respect to the transaction. Additionally, Financial Institutions must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and must disclose their conflicts of interest to Retirement Investors. The exemption is calibrated to align the Adviser’s interests with those of the plan or IRA customer, while leaving the Adviser and the Financial Institution the flexibility and discretion necessary to determine how best to satisfy the exemption’s standards in light of the unique attributes of their business. Financial Institutions relying on the exemption must obtain the Retirement Investor’s consent to participate in principal transactions and riskless principal transactions, and the Financial Institutions are subject to recordkeeping requirements. Executive Order 12866 and 13563 Statement Under Executive Orders 12866 and 13563, the Department must determine whether a regulatory action is ‘‘significant’’ and therefore subject to the requirements of the Executive Order and subject to review by the Office of Management and Budget (OMB). Executive Orders 12866 and 13563 direct agencies to assess all costs and VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing and streamlining rules, and of promoting flexibility. It also requires federal agencies to develop a plan under which the agencies will periodically review their existing significant regulations to make the agencies’ regulatory programs more effective or less burdensome in achieving their regulatory objectives. Under Executive Order 12866, ‘‘significant’’ regulatory actions are subject to the requirements of the Executive Order and review by the OMB. Section 3(f) of Executive Order 12866, defines a ‘‘significant regulatory action’’ as an action that is likely to result in a rule (1) having an annual effect on the economy of $100 million or more, or adversely and materially affecting a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local or tribal governments or communities (also referred to as ‘‘economically significant’’ regulatory actions); (2) creating serious inconsistency or otherwise interfering with an action taken or planned by another agency; (3) materially altering the budgetary impacts of entitlement grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) raising novel legal or policy issues arising out of legal mandates, the President’s priorities, or the principles set forth in the Executive Order. Pursuant to the terms of the Executive Order, OMB has determined that this action is ‘‘significant’’ within the meaning of Section 3(f)(1) of the Executive Order. Accordingly, the Department has undertaken an assessment of the costs and benefits of the proposal, and OMB has reviewed this regulatory action. The Department’s complete Regulatory Impact Analysis is available at www.dol.gov/ebsa. I. Background The Department proposed this class exemption on its own motion, pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in accordance with the procedures set forth in 29 CFR part 2570, subpart B (76 FR 66637 (October 27, 2011)). PO 00000 Frm 00146 Fmt 4701 Sfmt 4700 A. Regulation Defining a Fiduciary As explained more fully in the preamble to the Regulation, ERISA is a comprehensive statute designed to protect the interests of plan participants and beneficiaries, the integrity of employee benefit plans, and the security of retirement, health, and other critical benefits. The broad public interest in ERISA-covered plans is reflected in its imposition of stringent fiduciary responsibilities on parties engaging in important plan activities, as well as in the tax-favored status of plan assets and investments. One of the chief ways in which ERISA protects employee benefit plans is by requiring that plan fiduciaries comply with fundamental obligations rooted in the law of trusts. In particular, plan fiduciaries must manage plan assets prudently and with undivided loyalty to the plans and their participants and beneficiaries.3 In addition, they must refrain from engaging in ‘‘prohibited transactions,’’ which ERISA does not permit because of the dangers posed by the fiduciaries’ conflicts of interest with respect to the transactions.4 When fiduciaries violate ERISA’s fiduciary duties or the prohibited transaction rules, they may be held personally liable for the breach.5 In addition, violations of the prohibited transaction rules are subject to excise taxes under the Code. The Code also has rules regarding fiduciary conduct with respect to taxfavored accounts that are not generally covered by ERISA, such as IRAs. In particular, fiduciaries of these arrangements, including IRAs, are subject to the prohibited transaction rules and, when they violate the rules, to the imposition of an excise tax enforced by the Internal Revenue Service. Unlike participants in plans covered by Title I of ERISA, IRA owners do not have a statutory right to bring suit against fiduciaries for violations of the prohibited transaction rules. Under this statutory framework, the determination of who is a ‘‘fiduciary’’ is of central importance. Many of ERISA’s and the Code’s protections, duties, and liabilities hinge on fiduciary status. In relevant part, ERISA section 3(21)(A) and Code section 4975(e)(3) provide that a person is a fiduciary with respect to a plan or IRA to the extent he or she (i) exercises any discretionary authority or discretionary control with respect to management of such plan or IRA, or exercises any authority or control with respect to management or disposition of 3 ERISA section 404(a). section 406. ERISA also prohibits certain transactions between a plan and a party in interest. 5 ERISA section 409; see also ERISA section 405. 4 ERISA E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations its assets; (ii) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan or IRA, or has any authority or responsibility to do so; or, (iii) has any discretionary authority or discretionary responsibility in the administration of such plan or IRA. The statutory definition deliberately casts a wide net in assigning fiduciary responsibility with respect to plan and IRA assets. Thus, ‘‘any authority or control’’ over plan or IRA assets is sufficient to confer fiduciary status, and any persons who render ‘‘investment advice for a fee or other compensation, direct or indirect’’ are fiduciaries, regardless of whether they have direct control over the plan’s or IRA’s assets and regardless of their status as an investment adviser or broker under the federal securities laws. The statutory definition and associated responsibilities were enacted to ensure that plans, plan participants and IRA owners can depend on persons who provide investment advice for a fee to provide recommendations that are untainted by conflicts of interest. In the absence of fiduciary status, the providers of investment advice are neither subject to ERISA’s fundamental fiduciary standards, nor accountable under ERISA or the Code for imprudent, disloyal, or biased advice. In 1975, the Department issued a regulation, at 29 CFR 2510.3– 21(c)(1975) defining the circumstances under which a person is treated as providing ‘‘investment advice’’ to an employee benefit plan within the meaning of section 3(21)(A)(ii) of ERISA (the 1975 regulation).6 The 1975 regulation narrowed the scope of the statutory definition of fiduciary investment advice by creating a five-part test for fiduciary advice. Under the 1975 regulation, for advice to constitute ‘‘investment advice,’’ an adviser must— (1) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary that (4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan. The 1975 regulation provided that an adviser is a fiduciary 6 The Department of Treasury issued a virtually identical regulation, at 26 CFR 54.4975–9(c), which interprets Code section 4975(e)(3). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 with respect to any particular instance of advice only if he or she meets each and every element of the five-part test with respect to the particular advice recipient or plan at issue. The market for retirement advice has changed dramatically since the Department first promulgated the 1975 regulation. Individuals, rather than large employers and professional money managers, have become increasingly responsible for managing retirement assets as IRAs and participant-directed plans, such as 401(k) plans, have supplanted defined benefit pensions. At the same time, the variety and complexity of financial products have increased, widening the information gap between advisers and their clients. Plan fiduciaries, plan participants and IRA investors must often rely on experts for advice, but are unable to assess the quality of the expert’s advice or effectively guard against the adviser’s conflicts of interest. This challenge is especially true of retail investors, who typically do not have financial expertise and can ill-afford lower returns to their retirement savings caused by conflicts. The IRA accounts of these investors often account for all or the lion’s share of their assets, and can represent all of savings earned for a lifetime of work. Losses and reduced returns can be devastating to the investors who depend upon such savings for support in their old age. As baby boomers retire, they are increasingly moving money from ERISA-covered plans, where their employer has both the incentive and the fiduciary duty to facilitate sound investment choices, to IRAs where both good and bad investment choices are myriad and advice that is conflicted is commonplace. These rollovers are expected to approach $2.4 trillion cumulatively from 2016 through 2020.7 These trends were not apparent when the Department promulgated the 1975 regulation. At that time, 401(k) plans did not yet exist and IRAs had only just been authorized. As the marketplace for financial services has developed in the years since 1975, the five-part test has now come to undermine, rather than promote, the statutes’ text and purposes. The narrowness of the 1975 regulation has allowed advisers, brokers, consultants and valuation firms to play a central role in shaping plan and IRA investments, without ensuring the accountability that Congress intended for persons having such influence and responsibility. Even when plan sponsors, participants, beneficiaries, and IRA owners clearly relied on paid 7 Cerulli PO 00000 Associates, ‘‘Retirement Markets 2015.’’ Frm 00147 Fmt 4701 Sfmt 4700 21091 advisers for impartial guidance, the 1975 regulation has allowed many advisers to avoid fiduciary status and disregard basic fiduciary obligations of care and prohibitions on disloyal and conflicted transactions. As a consequence, these advisers have been able to steer customers to investments based on their own self-interest (e.g., products that generate higher fees for the adviser even if there are identical lower-fee products available), give imprudent advice, and engage in transactions that would otherwise be prohibited by ERISA and the Code without fear of accountability under either ERISA or the Code. In the Department’s amendments to the 1975 regulation defining fiduciary advice within the meaning of ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B) (the Regulation), which are also published in this issue of the Federal Register, the Department is replacing the existing regulation with one that more appropriately distinguishes between the sorts of advice relationships that should be treated as fiduciary in nature and those that should not, in light of the legal framework and financial marketplace in which IRAs and plans currently operate.8 The Regulation describes the types of advice that constitute ‘‘investment advice’’ with respect to plan or IRA assets for purposes of the definition of a fiduciary at ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B). The Regulation covers ERISA-covered plans, IRAs, and other plans not covered by Title I, such as Keogh plans, and health savings accounts described in Code section 223(d). As amended, the Regulation provides that a person renders investment advice with respect to assets of a plan or IRA if, among other things, the person provides, directly to a plan, a plan fiduciary, plan participant or beneficiary, IRA or IRA owner, the following types of advice, for a fee or other compensation, whether direct or indirect: (i) A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a 8 The Department initially proposed an amendment to its regulation defining a fiduciary within the meaning of ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B) on October 22, 2010, at 75 FR 65263. It subsequently announced its intention to withdraw the proposal and propose a new rule, consistent with the President’s Executive Orders 12866 and 13563, in order to give the public a full opportunity to evaluate and comment on the new proposal and updated economic analysis. The first proposed amendment to the rule was withdrawn on April 20, 2015, see 80 FR 21927. E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21092 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred or distributed from the plan or IRA; and (ii) A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, types of investment account arrangements (brokerage versus advisory), or recommendations with respect to rollovers, transfers or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made. In addition, in order to be treated as a fiduciary, such person, either directly or indirectly (e.g., through or together with any Affiliate), must: Represent or acknowledge that it is acting as a fiduciary within the meaning of ERISA or the Code with respect to the advice described; represent or acknowledge that it is acting as a fiduciary within the meaning of ERISA or the Code; render the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient; or direct the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA. The Regulation also provides that as a threshold matter in order to be fiduciary advice, the communication must be a ‘‘recommendation’’ as defined therein. The Regulation, as a matter of clarification, provides that a variety of other communications do not constitute ‘‘recommendations,’’ including nonfiduciary investment education; general communications; and specified communications by platform providers. These communications which do not rise to the level of ‘‘recommendations’’ under the Regulation are discussed more fully in the preamble to the final Regulation. The Regulation also specifies certain circumstances where the Department has determined that a person will not be treated as an investment advice fiduciary even though the person’s activities technically may satisfy the definition of investment advice. For example, the Regulation contains a provision excluding recommendations to independent fiduciaries with VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 financial expertise that are acting on behalf of plans or IRAs in arm’s length transactions, if certain conditions are met. The independent fiduciary must be a bank, insurance carrier qualified to do business in more than one state, investment adviser registered under the Investment Advisers Act of 1940 or by a state, broker-dealer registered under the Securities Exchange Act of 1934 (Exchange Act), or any other independent fiduciary that holds, or has under management or control, assets of at least $50 million, and: (1) The person making the recommendation must know or reasonably believe that the independent fiduciary of the plan or IRA is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies (the person may rely on written representations from the plan or independent fiduciary to satisfy this condition); (2) the person must fairly inform the independent fiduciary that the person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transaction and must fairly inform the independent fiduciary of the existence and nature of the person’s financial interests in the transaction; (3) the person must know or reasonably believe that the independent fiduciary of the plan or IRA is a fiduciary under ERISA or the Code, or both, with respect to the transaction and is responsible for exercising independent judgment in evaluating the transaction (the person may rely on written representations from the plan or independent fiduciary to satisfy this condition); and (4) the person cannot receive a fee or other compensation directly from the plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner for the provision of investment advice (as opposed to other services) in connection with the transaction. Similarly, the Regulation provides that the provision of any advice to an employee benefit plan (as described in ERISA section 3(3)) by a person who is a swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, or a swap clearing firm in connection with a swap or security-based swap, as defined in section 1a of the Commodity Exchange Act (7 U.S.C. 1a) and section 3(a) of the Exchange Act (15 U.S.C. 78c(a)) is not investment advice if certain conditions are met. Finally, the Regulation describes certain communications by employees of a plan sponsor, plan, or plan fiduciary that would not cause the employee to be an PO 00000 Frm 00148 Fmt 4701 Sfmt 4700 investment advice fiduciary if certain conditions are met. B. Prohibited Transactions The Department anticipates that the Regulation will cover many investment professionals who did not previously consider themselves to be fiduciaries under ERISA or the Code. Under the Regulation, these entities will be subject to the prohibited transaction restrictions in ERISA and the Code that apply specifically to fiduciaries. ERISA section 406(b)(1) and Code section 4975(c)(1)(E) prohibit a fiduciary from dealing with the income or assets of a plan or IRA in his own interest or his own account. ERISA section 406(b)(2), which does not apply to IRAs, provides that a fiduciary shall not ‘‘in his individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries.’’ ERISA section 406(b)(3) and Code section 4975(c)(1)(F) prohibit a fiduciary from receiving any consideration for his own personal account from any party dealing with the plan or IRA in connection with a transaction involving assets of the plan or IRA. Parallel regulations issued by the Departments of Labor and the Treasury explain that these provisions impose on fiduciaries of plans and IRAs a duty not to act on conflicts of interest that may affect the fiduciary’s best judgment on behalf of the plan or IRA.9 The prohibitions extend to a fiduciary causing a plan or IRA to pay an additional fee to such fiduciary, or to a person in which such fiduciary has an interest that may affect the exercise of the fiduciary’s best judgment as a fiduciary. Likewise, a fiduciary is prohibited from receiving compensation from third parties in connection with a transaction involving the plan or IRA.10 The purchase or sale of an investment in a principal transaction or riskless principal transaction between a plan or IRA and a fiduciary, resulting from the fiduciary’s provision of investment advice, implicates the prohibited 9 Subsequent to the issuance of these regulations, Reorganization Plan No. 4 of 1978, 5 U.S.C. App. (2010), divided rulemaking and interpretive authority between the Secretaries of Labor and the Treasury. The Secretary of Labor was given interpretive and rulemaking authority regarding the definition of fiduciary under both Title I of ERISA and the Internal Revenue Code. Id. section 102(a) (‘‘all authority of the Secretary of the Treasury to issue [regulations, rulings opinions, and exemptions under section 4975 of the Code] is hereby transferred to the Secretary of Labor’’). 10 29 CFR 2550.408b–2(e); 26 CFR 54.4975– 6(a)(5). E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations transaction rules set forth in ERISA section 406(b) and Code section 4975(c)(1)(E).11 Nevertheless, the Department recognizes that certain investment advice fiduciaries view the ability to execute principal transactions or riskless principal transaction as integral to the economically efficient distribution of fixed income securities. Therefore, in connection with the Regulation, the Department reviewed the existing legal framework to determine whether additional exemptions were needed for investment advice fiduciaries to engage in these transactions. In this regard, as further discussed below, fiduciaries who engage in such transactions under certain circumstances can avoid the ERISA and Code restrictions. Moreover, there are existing statutory and administrative exemptions, also discussed below, that already provide prohibited transaction relief for fiduciaries engaging in principal transactions and riskless principal transactions with plans and IRAs. Nevertheless, the Department determined that additional relief in this area is necessary and therefore, after reviewing the comments on the proposal, determined to grant this exemption for investment advice fiduciaries to engage in certain principal transactions and riskless principal transactions with plans and IRAs. mstockstill on DSK4VPTVN1PROD with RULES3 1. Blind Transactions Certain principal transactions and riskless principal transactions between a plan or IRA and an investment advice fiduciary may not need exemptive relief because they are blind transactions executed on an exchange. The ERISA Conference Report states that a transaction will, generally, not be a prohibited transaction if the transaction is an ordinary ‘‘blind’’ purchase or sale of securities through an exchange where neither the buyer nor the seller (nor the agent of either) knows the identity of the other party involved.12 2. Principal Transactions Permitted Under an Exemption As the prohibited transaction provisions demonstrate, ERISA and the Code strongly disfavor conflicts of interest. In appropriate cases, however, the statutes provide exemptions from their broad prohibitions on conflicts of interest. In addition, the Secretary of 11 The purchase or sale of an investment in a principal transaction or a riskless principal transaction between a plan or IRA and a fiduciary also is prohibited by ERISA section 406(a)(1)(A) and (D) and Code section 4975(c)(1)(A) and (D). 12 See H.R. Rep. 93–1280, 93rd Cong., 2d Sess. 307 (1974); see also ERISA Advisory Opinion 2004– 05A (May 24, 2004). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Labor has discretionary authority to grant administrative exemptions under ERISA and the Code on an individual or class basis, but only if the Secretary first finds that the exemptions are (1) administratively feasible, (2) in the interests of plans and their participants and beneficiaries and IRA owners, and (3) protective of the rights of the participants and beneficiaries of such plans and IRA owners. Accordingly, fiduciary advisers may always give advice without need of an exemption if they avoid the sorts of conflicts of interest that result in prohibited transactions. However, when they choose to give advice in which they have a conflict of interest, they must rely upon an exemption. a. Statutory Exemptions ERISA section 408(b)(14) provides a statutory exemption for transactions entered into in connection with the provision of fiduciary investment advice to a participant or beneficiary of an individual account plan or an IRA owner. The exemption provides relief for, among other things, the acquisition, holding, or sale of a security or other property as an investment under the plan pursuant to the investment advice. As set forth in ERISA section 408(g), the exemption is available if the advice is provided under an ‘‘eligible investment advice arrangement’’ which either (1) ‘‘provides that any fees (including any commission or other compensation) received by the fiduciary adviser for investment advice or with respect to the sale, holding or acquisition of any security or other property for purposes of investment of plan assets do not vary depending on the basis of any investment option selected’’ or (2) ‘‘uses a computer model under an investment advice program meeting the requirements of [ERISA section 408(g)(3)].’’ The ERISA section 408(g) exemptions include special conditions calibrated to insulate the fiduciary adviser from conflicts of interest. Code section 4975(d)(17) provides the same relief from the taxes imposed by Code section 4975(a) and (b). ERISA section 408(b)(16) provides relief for transactions involving the purchase or sale of securities between a plan and a party in interest, including an investment advice fiduciary, if the transactions are executed through an electronic communication network, alternative trading system, or similar execution system or trading venue. Among other conditions, subparagraph (B) of the statutory exemption requires that either: (i) ‘‘the transaction is effected pursuant to rules designed to match purchases and sales at the best PO 00000 Frm 00149 Fmt 4701 Sfmt 4700 21093 price available through the execution system in accordance with applicable rules of the Securities and Exchange Commission or other relevant governmental authority,’’ or (ii) ‘‘neither the execution system nor the parties to the transaction take into account the identity of the parties in the execution of trades[.]’’ The transactions covered by ERISA section 408(b)(16) include principal transactions between a plan and an investment advice fiduciary. Code section 4975(d)(19) provides the same relief from the taxes imposed by Code section 4975(a) and (b). b. Administrative Exemptions An administrative exemption for certain principal transactions will continue to be available through PTE 75–1.13 Specifically, PTE 75–1, Part IV, provides an exemption that is available to investment advice fiduciaries who are ‘‘market-makers.’’ Relief is available from ERISA section 406 for the purchase or sale of securities by a plan or IRA, from or to a market-maker with respect to such securities who is also an investment advice fiduciary with respect to the plan or IRA, or an affiliate of such fiduciary. However, PTE 75–1, Part IV, is amended today in a Notice, published elsewhere in this issue of the Federal Register, to require fiduciaries relying on the exemption to comply with the Impartial Conduct Standards that are also incorporated in this exemption. Further, Part II(1) of PTE 75–1 provides relief from ERISA section 406(a) and Code section 4975(c)(1)(A) through (D) for the purchase or sale of a security in a principal transaction between a plan or IRA and a brokerdealer registered under the Exchange Act or a bank supervised by the United States or a state. However, the exemption permits plans and IRAs to engage in principal transactions with broker-dealers and banks only if the broker-dealers and banks do not have or exercise any discretionary authority or control (except as a directed trustee) with respect to the investment of plan or IRA assets involved in the transaction, and do not render investment advice (within the meaning of 29 CFR 2510.3–21(c)) with respect to the investment of those assets. PTE 75– 1, Part II(1) will continue to be available to parties in interest that are not fiduciaries and that satisfy its conditions. In this regard, the Regulation provides that parties will not be investment advice fiduciaries if they engage in arm’s length transactions with 13 40 FR 50845 (Oct. 31, 1975), as amended, 71 FR 5883 (Feb. 3, 2006). E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21094 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations certain independent fiduciaries of a plan or IRA with financial expertise, including banks, insurance carriers, registered investment advisers, brokerdealers and persons holding, or possessing under management or control, total assets of at least $50 million, and who are capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies, and certain other conditions are satisfied. These nonfiduciary counterparties can continue to rely on PTE 75–1, Part II, for relief regarding principal transactions. In connection with the proposed Regulation, the Department recognized the need for additional relief. Accordingly, the Department proposed this exemption for principal transactions in certain debt securities between a plan, participant or beneficiary account, or IRA, and an investment advice fiduciary. The proposed exemption was intended to facilitate continued access by plan and IRA investors to certain types of investments commonly sold in principal transactions. The Department also proposed the Best Interest Contract Exemption, which is adopted elsewhere in this issue of the Federal Register. The Best Interest Contract Exemption provides broad relief for investment advice fiduciaries and their Affiliates and related entities to receive compensation as a result of investment advice to retail Retirement Investors (plan participants and beneficiaries, IRA owners, and certain plan fiduciaries, including small plan sponsors) under conditions specifically designed to address the conflicts of interest associated with the wide variety of payments advisers receive in connection with retail transactions involving plans and IRAs. At the same time that the Department has granted these new exemptions, it has also amended existing exemptions to ensure uniform application of the Impartial Conduct Standards, which are fundamental obligations of fair dealing and fiduciary conduct, and include obligations to act in the customer’s Best Interest, avoid misleading statements, and receive no more than reasonable compensation.14 Taken together, the new exemptions and amendments to existing exemptions ensure that Retirement Investors are consistently protected by Impartial Conduct Standards, regardless of the particular 14 The amended exemptions, published elsewhere in this Federal Register, include Prohibited Transaction Exemption (PTE) 75–1; PTE 77–4; PTE 80–83; PTE 83–1: PTE 84–24; and PTE 86–128. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 exemption upon which the adviser relies. The amendments also revoke certain existing exemptions, which provided little or no protections to IRA and nonERISA plan participants, in favor of a more uniform application of the Best Interest Contract Exemption in the market for retail investments. With limited exceptions, it is the Department’s intent that investment advice fiduciaries in the retail investment market rely on statutory exemptions, the Best Interest Contract Exemption, or this exemption to the extent that they receive conflicted forms of compensation that would otherwise be prohibited. The new and amended exemptions reflect the Department’s view that Retirement Investors should be protected by a more consistent application of fundamental fiduciary standards across a wide range of investment products and advice relationships, and that retail investors, in particular, should be protected by the stringent protections set forth in the Best Interest Contract Exemption and this exemption. When fiduciaries have conflicts of interest, they will uniformly be expected to adhere to fiduciary norms and to make recommendations that are in their customer’s Best Interest. These new and amended exemptions follow a lengthy public notice and comment process, which gave interested persons an extensive opportunity to comment on this proposed exemption, proposed Regulation and other related exemption proposals. The proposals initially provided for 75-day comment periods, ending on July 6, 2015, but the Department extended the comment periods to July 21, 2015. The Department then held four days of public hearings on the new regulatory package, including the proposed exemptions, in Washington, DC from August 10 to 13, 2015, at which over 75 speakers testified. The transcript of the hearing was made available on September 8, 2015, and the Department provided additional opportunity for interested persons to comment on the proposals or hearing transcript until September 24, 2015. A total of over 3000 comment letters were received on the new proposals. There were also over 300,000 submissions made as part of 30 separate petitions submitted on the proposal. These comments and petitions came from consumer groups, plan sponsors, financial services companies, academics, elected government officials, trade and industry associations, and others, both in support and in PO 00000 Frm 00150 Fmt 4701 Sfmt 4700 opposition to the rule.15 The Department has reviewed all comments, and after careful consideration of the comments, has decided to grant this exemption. II. Exemption for Principal Transactions in Certain Assets As finalized, this exemption for certain principal transactions and riskless principal transactions retains the core protections of the proposed exemption, but with revisions designed to facilitate implementation and compliance with the exemption’s terms. In broadest outline, the exemption permits Advisers and the Financial Institutions that employ or otherwise retain them to enter into principal transactions and riskless principal transactions with plans and IRAs regarding certain investments, provided that they give advice regarding the transactions that is in their customers’ Best Interest and the Financial Institution implements basic protections against the dangers posed by conflicts of interest. In particular, to rely on the exemption, Financial Institutions must: • Acknowledge fiduciary status with respect to any investment advice regarding principal transactions or riskless principal transactions; • Adhere to Impartial Conduct Standards requiring them to Æ Give advice that is in the Retirement Investor’s Best Interest (i.e., prudent advice that is based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to financial or other interests of the Adviser, Financial Institution or any Affiliates or other parties); Æ Seek to obtain the best execution reasonably available under the circumstances with respect to the transaction; and Æ Make no misleading statements about investment transactions, compensation, and conflicts of interest; • Implement policies and procedures reasonably and prudently designed to prevent violations of the Impartial Conduct Standards; • Refrain from giving or using incentives for Advisers to act contrary to the customer’s Best Interest; and • Make additional disclosures. Advisers relying on the exemption must comply with the Impartial Conduct Standards when making investment recommendations regarding principal transactions and riskless principal transactions. 15 As used throughout this preamble, the term ‘‘comment’’ refers to information provided through these various sources, including written comments, petitions and witnesses at the public hearing. E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations The exemption takes a principlesbased approach that permits Financial Institutions and Advisers to enter into transactions that would otherwise be prohibited. The exemption holds Financial Institutions and their Advisers responsible for adhering to fundamental standards of fiduciary conduct and fair dealing, while leaving them the flexibility and discretion necessary to determine how best to satisfy these basic standards in light of the unique attributes of their particular businesses. The exemption’s principles-based conditions, which are rooted in the law of trust and agency, have the breadth and flexibility necessary to apply to a large range of investment and compensation practices, while ensuring that Advisers put the interests of Retirement Investors first. When Advisers choose to give advice regarding principal transactions and riskless principal transactions to Retirement Investors, they must protect their customers from the dangers posed by conflicts of interest. In order to ensure compliance with the exemption’s broad protective standards and purposes, the exemption gives special attention to the enforceability of the exemption’s terms by Retirement Investors. When Financial Institutions and Advisers breach their obligations under the exemption and cause losses to Retirement Investors, it is generally critical that the investors have a remedy to redress the injury. The existence of enforceable rights and remedies gives Financial Institutions and Advisers a powerful incentive to comply with the exemption’s standards, implement policies and procedures that are more than window-dressing, and carefully police conflicts of interest to ensure that the conflicts of interest do not taint the advice. Thus, in the case of IRAs and nonERISA plans, the exemption requires the Financial Institution to commit to the Impartial Conduct Standards in an enforceable contract with Retirement Investor customers. The exemption does not similarly require the Financial Institution to execute a separate contract with ERISA investors (plan participants, beneficiaries, and fiduciaries), but the Financial Institution must acknowledge its fiduciary status and that of its Advisers, and ERISA investors can directly enforce their rights to proper fiduciary conduct under ERISA section 502(a)(2) and (3). In addition, the exemption safeguards Retirement Investors’ enforcement rights by providing that Financial Institutions and Advisers may not rely on the exemption if they include contractual VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 provisions disclaiming liability for compensatory remedies or waiving or qualifying Retirement Investors’ right to pursue a class action or other representative action in court. However, the exemption does permit Financial Institutions to include provisions waiving the right to punitive damages or rescission as contract remedies to the extent permitted by other applicable laws. In the Department’s view, the availability of make-whole relief for such claims is sufficient to protect Retirement Investors and incentivize compliance with the exemption’s conditions. While the final exemption retains the proposed exemption’s core protections, the Department has revised the exemption to ease implementation in response to commenters’ concerns about the exemption’s workability. Thus, for example, the final exemption eliminates the contract requirement altogether in the ERISA context and simplifies the mechanics of contract-formation for IRAs and plans not covered by Title I of ERISA. For new customers, the final exemption provides that the required contract terms may simply be incorporated in the Financial Institution’s account opening documents and similar commonly-used agreements. The exemption additionally permits reliance on a negative consent process for existing contract holders. The Department recognizes that Retirement Investors may talk to numerous Advisors in numerous settings over the course of their relationship with a Financial Institution. Accordingly, the exemption also simplifies execution of the contract by simply requiring the Financial Institution to execute the contract, rather than each of the individual Advisers from whom the Retirement Investor receives advice. For similar reasons, the exemption does not require execution of the contract at the start of Retirement Investors’ conversations with Advisers, as long as it is entered into prior to or at the same time as the recommended transaction. As a means of facilitating use of the exemption, the Department also reduced compliance burdens by eliminating some of the conditions that were not critical to the exemption’s protective purposes, and expanding the scope of the exemption’s coverage (e.g., by covering interests in unit investment trusts (UITs) and certificates of deposit (CDs)). The Department eliminated the requirement of adherence to other state and federal laws relating to advice as unduly expansive and duplicative of other laws; dropped a two-quote requirement; and eliminated a mark-up PO 00000 Frm 00151 Fmt 4701 Sfmt 4700 21095 and mark-down disclosure requirement. In addition, the Department streamlined the disclosure conditions by simplifying the obligations. The Department also provided a mechanism for correcting good faith violations of the disclosure conditions, so that Financial Institutions would not lose the benefit of the exemption as a result of such good faith errors and would have an incentive to promptly correct them. While making these changes to facilitate the implementation of the exemption, the Department emphasizes that the exemption is limited because of the severity of the conflicts of interest associated with principal transactions. When acting as a principal in a transaction involving a plan, participant or beneficiary account, or IRA, a fiduciary can have difficulty reconciling its duty to avoid conflicts of interest with its concern for its own financial interests as the Retirement Investor’s counterparty. Of primary concern are issues involving liquidity, pricing, transparency, and the fiduciary’s possible incentive to ‘‘dump’’ unwanted assets. The scope of this exemption balances the Department’s significant concerns regarding principal transactions with the need to preserve market choice for plans, participants and beneficiary accounts, and IRAs. The comments on this exemption, the Best Interest Contract Exemption, the Regulation, and related exemptions have helped the Department improve this exemption, while preserving and enhancing its protections. As described above, the Department has revised the exemption to facilitate implementation and compliance with the exemption, without diluting its core protections, which are critical to reducing the harm caused by conflicts of interest in the marketplace for advice. The taxpreferred investments covered by the exemption are critical to the financial security and physical health of investors. After consideration of the comments, the Department remains convinced of the importance of the exemption’s core protections. ERISA and the Code are rightly skeptical of the dangers posed by conflicts of interest, and generally prohibit conflicted advice. Before granting exemptive relief, the Department has a statutory obligation to ensure that the exemption is in the interests of plan and IRA investors and protective of their rights. Adherence to the fundamental fiduciary norms and basic protective conditions of this exemption helps ensure that investment recommendations are not driven by Adviser conflicts, but by the Best Interest of the Retirement Investor. The E:\FR\FM\08APR3.SGM 08APR3 21096 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations conditions of this exemption are carefully calibrated to permit principal transaction and riskless principal transactions in certain investments, while protecting Retirement Investors’ interest in receiving sound advice on vitally important investments. Based upon these protective conditions, the Department finds that the exemption is administratively feasible, in the interests of plans and their participants and beneficiaries and IRA owners, and protective of the rights of participants and beneficiaries of plans and IRA owners. The preamble sections that follow provide a much more detailed discussion of the exemption’s terms, comments on the exemption, and the Department’s responses to those comments. After a discussion of the exemption’s scope and limitations, the preamble discusses the conditions of the exemptions. mstockstill on DSK4VPTVN1PROD with RULES3 A. Scope of Relief in the Exemption The exemption provides relief for ‘‘Advisers’’ and ‘‘Financial Institutions’’ to enter into ‘‘principal transactions’’ and ‘‘riskless principal transactions’’ in ‘‘principal traded assets’’ with plans and IRAs. For purposes of the exemption, a principal transaction is a transaction in which an Adviser or Financial Institution is purchasing from or selling to the plan, participant or beneficiary account, or IRA on behalf of the account of the Financial Institution or the account of any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Financial Institution. The term principal transaction does not include a riskless principal transaction as defined in the exemption. A riskless principal transaction is defined as a transaction in which a Financial Institution, after having received an order from a Retirement Investor to buy or sell a principal traded asset, purchases or sells the asset for the Financial Institution’s own account to offset the contemporaneous transaction with the Retirement Investor. The exemption uses the term ‘‘Retirement Investor’’ to describe the types of persons who can be investment advice recipients under the exemption, and the term ‘‘Affiliate’’ to describe people and entities with a connection to the Adviser or Financial Institution. These terms are defined in Section VI of this exemption. The following sections discuss the scope and conditions of the exemption as well as key definitional terms. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 1. Principal Traded Assets The exemption provides relief for principal transactions and riskless principal transactions involving certain investments, referred to as ‘‘principal traded assets,’’ between a plan, participant or beneficiary account, or IRA, and an Adviser, Financial Institution or an entity in a control relationship with the Financial Institution, when the transaction is a result of an Adviser’s or Financial Institution’s provision of investment advice. Relief is provided from ERISA sections 406(a)(1)(A) and (D), and 406(b)(1) and (2), and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(A), (D) and (E). Relief has not been provided in this exemption from ERISA section 406(b)(3) and Code section 4975(c)(1)(F), which prohibit a fiduciary from receiving any consideration for its own personal account from any party dealing with the plan or IRA in connection with a transaction involving the assets of the plan or IRA. The principal traded assets that are permitted to be purchased by plans, participant and beneficiary accounts, and IRAs, under the exemption include CDs, interests in UITs, and securities within the exemption’s definition of ‘‘debt security.’’ Debt securities are generally defined as corporate debt securities offered pursuant to a registration statement under the Securities Act of 1933; treasury securities; agency securities; and assetbacked securities that are guaranteed by an agency or government sponsored enterprise (GSE). In addition, the final exemption includes a feature under which the definition of principal traded asset can be expanded without amending the class exemption. Under the definition of principal traded asset, investments can be added to the class exemption in the future based on an individual exemption granted by the Department. Accordingly, a principal traded asset for purposes of the class exemption also includes an investment that is permitted to be purchased under an individual exemption granted by the Department after the issuance date of this exemption, that provides relief for investment advice fiduciaries to engage in the purchase of the investment in a principal transaction or riskless principal transaction with a plan or IRA under the same conditions as this exemption. To the extent parties wish to expand the definition of principal traded asset in the future, they can submit a request for an individual exemption to the Department setting PO 00000 Frm 00152 Fmt 4701 Sfmt 4700 forth the specific attributes of the principal traded asset, the sales and compensation practices, and how conflicts of interest will be mitigated with respect to principal transactions and riskless principal transactions in that principal traded asset. If the exemption is granted, the class exemption will expand to include that investment within the definition of principal traded asset. The exemption’s definition of principal traded assets is more expansive with respect to the sale of principal traded assets by plans and IRAs. The definition extends to ‘‘securities or other investment property,’’ which corresponds to the broad range of assets that can be recommended by fiduciary advisers under the Regulation. This permits trades that may be necessary, according to commenters, when a Retirement Investor seeks to sell an investment and cannot obtain a reasonable price from a third party. In addition, in response to commenters, the Department expanded the scope of the Best Interest Contract Exemption to cover riskless principal transactions involving all investment products. As proposed, the exemption limited the types of assets that could be traded (both bought and sold) on a principal basis to corporate debt securities offered pursuant to a registration statement under the Securities Act of 1933, treasury securities, and agency securities. The Department received many comments regarding this limitation and the general intent of the exemption. Supporting comments emphasized that the exemption’s limited scope and conditions were appropriate for the mitigation of conflicts of interest and the protection of plans and IRAs. One commenter particularly supported the exemption’s approach of granting relief only to those securities least likely to be subject to principal trading abuses. The commenter supported, in particular, the exclusion of municipal securities. Others urged the Department to broaden the scope of the exemption. Many of these commenters argued that principal transactions are necessary for the maintenance of inventory, liquidity, access to investments, and best execution. They contended that the failure to provide broader relief would drive up the cost to investors, and hinder normal transactions that are generally classified as facilitation trades or riskless principal transactions. Commenters took the position that the Department should not substitute its judgment for the judgment of investors and advisers. In particular, commenters E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 urged the Department to: (a) Provide relief for riskless principal transactions, (b) add specific additional securities to the scope of the exemption, and (c) provide broad principal transaction relief for all securities and other property. a. Riskless Principal Transactions A number of comments noted that the proposal did not specifically address riskless principal transactions. In a riskless principal transaction, according to a commenter, a Financial Institution, after receiving an order to purchase or sell a security from a customer, purchases or sells the investment for its own account to offset the contemporaneous transaction with the customer. Commenters argued that riskless principal transactions are the functional equivalent of agency transactions. A commenter asserted that for this reason, riskless principal transactions would not involve the incentive to dump unwanted investments on Retirement Investors, which was one of the Department’s concerns. Another commenter indicated that without wider availability of riskless principal transactions, many investments would not be available at all to plans and IRAs because it is typical for broker-dealers to engage in transactions with third parties on a riskless principal basis rather than a pure agency basis. One commenter stated that this is because counterparties may not want to assume settlement risk with an investor. After consideration of these comments, the Department concurs with commenters that broader relief in this area is appropriate. The Department intended that the proposal cover riskless principal transactions within the general meaning of principal transactions, but the transactions would have been limited to the debt securities covered under the proposed exemption. The Department agrees with commenters that, to the extent a Financial Institution engages in a transaction based on an existing customer order, the riskless principal transaction can be viewed as functionally similar to an agency transaction, and the Department accepts the position of commenters that some investments may not be functionally available without this relief. For this reason, the Department expanded the scope of the companion Best Interest Contract Exemption to permit riskless principal transactions in all investments, and provide relief for compensation received in connection with such transactions, subject to the conditions of that exemption. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 The Department also clarified that this exemption is available for riskless principal transactions involving principal traded assets. The definition of a principal transaction now explicitly excludes riskless principal transactions, and the exemption’s scope specifically encompasses both principal transactions and separately-defined riskless principal transactions. In this manner, the exemption now clearly draws a distinction between principal transactions and riskless principal transactions and provides relief for both with respect to principal traded assets. This approach results in some overlap between coverage of riskless principal transactions in the Best Interest Contract Exemption and this exemption. With respect to a recommended purchase of an investment that occurs in a riskless principal transaction, this exemption is available for principal traded assets. The Best Interest Contract Exemption, however, provides broader relief for all recommended purchases. In addition, sales from a plan or IRA in riskless principal transactions can occur under either exemption. This approach is intended to provide flexibility to Financial Institutions relying on the exemptions. The Department believes that some Financial Institutions have business models that involve only riskless principal transactions. These Financial Institutions may not, as a general matter, hold investments in inventory to sell in principal transactions, but they may execute certain transactions as riskless principal transactions. Financial Institutions that do not engage in principal transactions, as defined in the exemptions, do not have to rely on this exemption at all, and can organize their practices to comply with the Best Interest Contract Exemption alone. On the other hand, Financial Institutions that engage in both principal transactions and riskless principal transactions may want to organize their practices to comply with this exemption. They may not be certain at the outset whether a particular purchase by a plan or IRA will be executed as a principal transaction or a riskless principal transaction. Those Financial Institutions can rely on this exemption for principal traded assets that may be sold to plans and IRAs without concern for whether the transaction is, in fact a riskless principal transaction or principal transaction. b. Adding to the Definition of Principal Traded Assets Some commenters requested that this exemption extend to principal transactions in specific additional types PO 00000 Frm 00153 Fmt 4701 Sfmt 4700 21097 of securities or investments, including municipal securities, currency, agency debt securities, CDs (including brokered CDs), asset backed securities, unit investment trusts (UITs), equities (including new issue and initial public offerings), new issue of debt securities, preferred securities, foreign corporate securities, foreign sovereign debt, debt of a charitable organization, derivatives, bank note offerings and wrap or other contracts that are not insurance products. In response, the Department added to this final exemption CDs, UITs, and asset backed securities guaranteed by an agency or GSE. Both CDs and UITs were included as investments permitted to be sold under the proposed Best Interest Contract Exemption, and commenters informed us that these investments are typically sold in principal transactions. Without relief for CDs and UITs in this exemption, commenters asserted that Retirement Investors might lose access to such investments. Commenters indicated that these investments were common investments in ERISA plans, IRAs and non-ERISA plans. The Department therefore included them in this final exemption. As with the exemptive relief originally proposed regarding principal transactions in debt securities, the Department believes that the conflicts of interest created by principal transactions in CDs and UITs are effectively addressed by the conditions of this exemption so as to protect the interests of Retirement Investors while maintaining Retirement Investors’ access to these investments. Agency and GSE guaranteed asset backed securities were always intended to be included in the definition of debt security. The proposal provided that agency debt securities were defined by reference to the Financial Industry Regulatory Authority (FINRA) rule 6710(l).16 Commenters informed us that the Department’s definition omitted agency and GSE mortgage backed securities. Based on the Department’s original intent to provide relief for these investments, and the view that the conditions are protective in these contexts, the Department included them in the final exemption. Reflecting this expansion of relief to CDs, UITs and agency and GSE guaranteed asset backed securities, the final exemption uses the term ‘‘principal traded asset,’’ rather than ‘‘debt security’’ to describe the 16 FINRA is registered with the Securities and Exchange Commission (SEC) as a national securities association and is a self-regulatory organization, as those terms are defined in the Exchange Act, which operates under SEC oversight. E:\FR\FM\08APR3.SGM 08APR3 21098 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations customer to principal transactions; oral or written pre-transaction disclosure and customer consent; written confirmation to the customer; and written annual disclosure to the customer of transactions entered into in reliance on the rule. Commenters also focused on principal transactions involving sales by plans and IRAs. Commenters indicated that broader relief was necessary to provide liquidity for Retirement Investors. They said that Financial Institutions serve an essential function in purchasing securities from their clients who need such liquidity. The Department did not accept the commenters’ call for relief for all principal transactions. The Department’s approach in the proposal of this exemption was intentionally narrow, based on the potentially acute conflicts of interest associated with principal transactions that are recommended by fiduciaries. The Department believes that broad relief for all principal transactions, without tailored conditions, is inconsistent with longstanding principles that fiduciaries c. Principal Transaction Relief for All must act with loyalty to Retirement Securities and Other Property Investors. Because the fiduciary is on Other commenters sought to more both sides of a principal transaction, the generally expand the scope of the fiduciary duty of loyalty is sorely tested. exemption. Some commenters felt that In addition, the securities typically unrestricted relief should be provided with respect to all principal transactions traded in principal transactions often lack objective market prices and with few, if any, conditions. Some of Retirement Investors may have these commenters took issue with the difficulty evaluating the fairness of a Department’s decision to place any particular transaction. Principal traded limitations at all on investments that investments also can be associated with can be purchased or sold in a principal low liquidity, low transparency and the transaction. The commenters expressed possible incentive to dump unwanted the view that the Department was investments. substituting its judgment for those of individual investors and their advisers. Therefore, although the Department’s In support of their approach, a few approach harmonizes in many ways, as commenters urged the Department to discussed below, with the disclosures more closely hew to the approach taken required by the SEC’s Temporary Rule under the securities laws, citing 206(3)–3T, the Department did not Temporary Rule 206(3)–3T issued by adopt an exemption that is as broad in the Securities and Exchange scope. The Department also notes in this Commission (SEC) under the Investment respect that the SEC has not yet 17 According to the Advisers Act of 1940. finalized its approach to rule 206(3)–3T, commenters, Temporary Rule 206(3)–3T and the SEC has indicated the delay is applies to institutions that are dually related to the SEC’s consideration of registered as investment advisers and regulatory standards of care for brokerbroker-dealers and to transactions in dealers and investment advisers under non-discretionary accounts at such section 913 of the Dodd-Frank Wall institutions, and it permits principal Street Reform and Consumer Protection transactions involving all securities Act (Dodd-Frank Act). In the most unless the investment adviser or recent release proposing to extend the Affiliate is the issuer of, or, at the time Temporary Rule, the SEC stated: of the sale, an underwriter of, a security As part of our broader consideration of the that is not an investment grade debt regulatory requirements applicable to brokersecurity. The rule generally requires dealers and investment advisers, we intend written prospective consent by the mstockstill on DSK4VPTVN1PROD with RULES3 investments that can be purchased or sold. As explained in greater detail below, the Department did not expand the purchase provisions of the exemption, as some commenters suggested, to include other investments such as municipal securities, currency, asset backed securities, equities (including new issue and initial public offerings), new issue of debt securities, preferred securities, foreign corporate securities, foreign sovereign debt, debt of a charitable organization, derivatives, bank note offerings and wrap or other contracts that are not insurance products. The Department determined that the conditions of this exemption may not be appropriately tailored to these types of investments. The Department invites interested parties to request an individual exemption for other investments that they would like to see included in this class exemption. This will provide the Department with the opportunity to gain additional information about those investments, their sales practices and associated conflicts of interest. 17 17 to carefully consider principal trading by advisers, including whether rule 206(3)–3T CFR 275.206(3)–3T. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 PO 00000 Frm 00154 Fmt 4701 Sfmt 4700 should be substantively modified, supplanted, or permitted to sunset.18 Given the SEC’s ongoing consideration of these issues, the Department does not believe there is a significant advantage to mirroring the scope of the Temporary Rule. Although the Department retained the limited definition of principal traded asset, as discussed above, for recommendations that a plan or IRA purchase an investment, the Department did provide broader relief for recommended sales from a plan or IRA to a Financial Institution. The Department is persuaded by commenters that a broader exemption is necessary to provide liquidity to plans and IRAs. The Department also notes that the final Regulation provides additional ways in which parties can engage in principal transactions and riskless principal transactions and avoid prohibited transactions. The Regulation provides that a person is not a fiduciary when the person engages in an arm’s length transaction with an independent plan fiduciary with financial expertise, as defined in the Regulation. Financial professionals that engage in such transactions are not considered fiduciaries, and may rely on other exemptions such as PTE 75–1, Part II, or ERISA section 408(b)(17) and Code section 4975(d)(20), for a broader range of principal transactions and riskless principal transactions. Therefore, the concerns of commenters such as the Stable Value Investment Association, about principal transactions involving a stable value fund managed by a professional investment manager, should be addressed in that fashion. Finally, this exemption does not affect the ability of a self-directed investor to obtain the services of a financial professional to effect or execute a transaction involving any type of investment, in the absence of investment advice. In that sense, the Department is not limiting investment opportunities for individual investors or substituting the Department’s judgment for theirs. Instead, the exemption is aimed squarely at conflicted investment advice by fiduciaries and is intended to minimize the harms of such conflicts of interest. In this regard, one commenter requested a clarification as to whether an exemption is necessary for the provision of principal transaction services where the services do not involve the provision of individual recommendations to a plan or IRA. In 18 See SEC’s Release No. IA–3893, August 12, 2014. E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 response, the Department notes that relief from ERISA section 406(b) would only be necessary to the extent the service provider was acting as a fiduciary. To the extent the service provider does not make recommendations, it does not act as a fiduciary investment adviser. If the service provider is not a fiduciary, ERISA section 406(b) relief is not necessary, and the other exemptions referenced above, apply. 2. Exclusions The exclusions set forth in Section I(c) of the proposal remain a part of the final exemption. First, under Section I(c)(1), Advisers who have or exercise discretionary authority or discretionary control with respect to management of the assets of a plan, participant or beneficiary account, or IRA or who exercise any discretionary authority or control respecting management or the disposition of the assets, or have any discretionary authority or discretionary responsibility in the administration of the plan, participant or beneficiary account, or IRA, may not take advantage of relief under the exemption to engage in principal transactions and riskless principal transactions with such investors. A comment related to this provision asked that the limitation on investment managers be modified so that Financial Institutions that sponsor separately managed accounts that use independent, individual investment managers should be permitted to engage in principal transactions on behalf of their managed plans and IRAs with the sponsor. The Department did not adopt this suggestion. Instead, the Department notes that the Regulation was revised to provide that a person does not act as a fiduciary when engaged in an arm’s length transaction with a plan fiduciary with financial expertise under the circumstances set forth in the Regulation. In such circumstances, the financial professionals may, therefore, rely on existing exemptions for nonfiduciary principal transactions and riskless principal transactions. Second, under Section I(c)(2), the exemption is not available for a principal transaction involving a plan covered by Title I of ERISA if the Adviser or Financial Institution, or any Affiliate is the employer of employees covered by the plan. In accordance with this condition, the exemption is not available for a principal transaction entered into as part of a rollover from such a plan to an IRA, where the principal transaction is being executed by the plan, not the IRA. This restriction on employers does not apply in the case VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 of an IRA or other similar plan that is not covered by Title I of ERISA. Accordingly, an Adviser or Financial Institution may provide advice to the beneficial owner of an IRA who is employed by the Adviser, its Financial Institution or an Affiliate, and receive compensation as a result, provided the IRA is not covered by Title I of ERISA. No comments were received specific to the principal transactions exemption on proposed Section I(c)(2). Comments were received, however, on the same language, proposed in Section I(c)(1), of the Best Interest Contract Exemption. Specifically, industry commenters requested elimination of this exclusion in the Best Interest Contract Exemption. In particular, they said that Financial Institutions in the business of providing investment advice should not be compelled to hire a competitor to provide services to the Financial Institution’s own plan. They warned that the exclusion could effectively prevent these Financial Institutions from providing any investment advice to their employees. Some commenters additionally stated that for compliance reasons, employees of a Financial Institution are often required to maintain their financial assets with that Financial Institution. As a result, they argued employees of Financial Institutions could be denied access to investment advice on their retirement savings. As with the Best Interest Contract Exemption, the Department has not scaled back the exclusion. As noted above, the Department did not receive comments requesting that Financial Institutions be able to engage in principal transactions with their inhouse plans. More generally, however, the Department continues to be concerned that the danger of abuse is compounded when the advice recipient receives recommendations from the employer, upon whom he or she depends for a job, to make investments in which the employer has a financial interest. To protect employees from abuse, employers generally should not be in a position to use their employees’ retirement benefits as potential revenue or profit sources, without stringent safeguards. See, e.g., ERISA section 403(c)(1) (generally providing that ‘‘the assets of a plan shall never inure to the benefit of any employer’’). Additionally, the exclusion of employers in Section I(c) does not apply in the case of an IRA or other similar plan that is not covered by Title I of ERISA. The decision to open an IRA account or obtain IRA services from the employer is much more likely to be entirely voluntary on the employees’ part than would be true PO 00000 Frm 00155 Fmt 4701 Sfmt 4700 21099 of their interactions with the retirement plan sponsored and designed by their employer for its employee benefit program. Accordingly, an Adviser or Financial Institution may provide advice to the beneficial owner of an IRA who is employed by the Adviser, its Financial Institution or an Affiliate regarding a principal transaction or riskless principal transaction, and engage in a principal transaction or riskless principal transaction as a result, provided the IRA is not covered by Title I of ERISA, and the conditions of this exemption are satisfied. Section I(c)(2) further provides that the exemption is unavailable if the Adviser or Financial Institution is a named fiduciary or plan administrator, as defined in ERISA section 3(16)(A) with respect to an ERISA plan, or an Affiliate thereof, that was selected to provide advice to the plan by a fiduciary who is not independent of them. This provision is intended to disallow the selection of Advisers and Financial Institutions by named fiduciaries or plan administrators that have a significant financial stake in the selection and was adopted in the final exemption unchanged from the proposal.19 B. Conditions of the Exemption Section I, discussed above, establishes the scope of relief provided by this Principal Transactions Exemption. Sections II–V set forth the conditions of the exemption. All applicable conditions must be satisfied in order to avoid application of the specified prohibited transaction provisions of ERISA and the Code. The Department finds that, subject to these conditions, the exemption is administratively feasible, in the interests of plans and of their participants and beneficiaries, and IRA owners and protective of the rights of the participants and beneficiaries of such plans and IRA owners. Under ERISA section 408(a), and Code section 4975(c)(2), the Secretary may not grant an exemption without making such findings. The conditions of the exemption, comments on those conditions, and the Department’s responses, are described below. 1. Enforceable Right to Best Interest Advice (Section II) Section II of the exemption sets forth the requirements that establish the Retirement Investor’s enforceable right 19 The definition of ‘‘independent’’ was adjusted in response to comments, as discussed below, to permit circumstances in which the person selecting the Adviser and Financial Institution could receive no more than 2% of its compensation from the Financial Institution. E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21100 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations to adherence to the Impartial Conduct Standards and related conditions. For advice to certain Retirement Investors— specifically, advice regarding transactions with IRAs, and plans that are not covered by Title I of ERISA (nonERISA plans), such as Keogh plans— Section II(a) requires the Financial Institution and Retirement Investor to enter into a written contract that includes the provisions described in Section II(b)–(d) of the exemption and that also does not include any of the ineligible provisions described in Section II(f) of the exemption, and provide the disclosures set forth in Section II(e). As discussed further below, pursuant to Section II(g) of the exemption, advice to Retirement Investors regarding ERISA plans does not have to be subject to a written contract but Advisers and Financial Institutions must comply with the substantive standards established in Section II(b)–(e) to avoid liability for a non-exempt prohibited transaction. The contract with Retirement Investors regarding IRAs and non-ERISA plans must include the Financial Institution’s acknowledgment of its fiduciary status and that of its Advisers, as required by Section II(b); the Financial Institution’s agreement that it and its Advisers will adhere to the Impartial Conduct Standards, including a Best Interest standard, as required by Section II(c); the Financial Institution’s warranty that it has adopted and will comply with certain policies and procedures, including anti-conflict policies and procedures reasonably and prudently designed to ensure that Advisers adhere to the Impartial Conduct Standards, as required by Section II(d). The Financial Institution’s disclosure of information about Material Conflicts of Interest associated with principal transactions and riskless principal transactions, as required by Section II(e), may be provided in the contract or in a separate single written disclosure. Section II(f) generally provides that the exemption is unavailable if the contract includes exculpatory provisions or provisions waiving the rights and remedies of the plan, IRA or Retirement Investor, including their right to participate in a class action in court. The contract may, however, provide for binding arbitration of individual claims, and may waive contractual rights to punitive damages or rescission. The contract between the IRA or nonERISA plan, and the Financial Institution, forms the basis of the IRA’s or non-ERISA plan’s enforcement rights. The Department intends that all the contractual obligations imposed on the VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Financial Institution (the Impartial Conduct Standards and warranties) will be actionable by the IRAs and nonERISA plans. Because these standards are contractually imposed, an IRA or non-ERISA plan has a contract claim if, for example, its Adviser recommends an investment product that is not in the Best Interest of the IRA or other nonERISA plan. In the Department’s view, these contractual rights serve a critical function for IRA owners and participants and beneficiaries of nonERISA plans. Unlike participants and beneficiaries in plans covered by Title I of ERISA, IRA owners and participants and beneficiaries in non-ERISA plans do not have an independent statutory right to bring suit against fiduciaries for violation of the prohibited transaction rules. Nor can the Secretary of Labor bring suit to enforce the prohibited transactions rules on their behalf.20 Thus, for investors in IRAs and nonERISA plans, the contractual requirement creates a mechanism for investors to enforce their rights and ensures that they will have a remedy for misconduct. In this way, the exemption creates a powerful incentive for Financial Institutions and Advisers alike to oversee and adhere to basic fiduciary standards when engaging in principal transactions and riskless principal transactions, without requiring the imposition of unduly rigid and prescriptive rules and conditions. Under Section II(g), however, the written contract requirement does not apply to advice to Retirement Investors regarding transactions with plans that are covered by Title I of ERISA (ERISA plans) in light of the existing statutory framework which provides a preexisting enforcement mechanism for these investors and the Department. Instead, Advisers and Financial Institutions must satisfy the provisions in Section II(b)–(e) as conditions of the exemption when transacting with such Retirement Investors. Under the terms of the exemptions, the Financial Institution must provide a written acknowledgment of its and its Advisers’ fiduciary status prior to or at the same time as the execution of the transaction, although it does not have to be part of a contract, as required by Section II(b); 20 An excise tax does apply in the case of a violation of the prohibited transaction provisions of the Code, generally equal to 15% of the amount involved. The excise tax is generally self-enforced; requiring parties not only to realize that they’ve engaged in a prohibited transaction but also to report it and pay the tax. Parties who have participated in a prohibited transaction for which an exemption is not available must pay the excise tax and file Form 5330 with the Internal Revenue Service. PO 00000 Frm 00156 Fmt 4701 Sfmt 4700 the Financial Institution and its Advisers must comply with the Impartial Conduct Standards, as required by Section II(c); the Financial Institutions must establish and comply with certain policies and procedures, as required by Section II(d); and they must provide the disclosures required by Section II(e). If these conditions are not satisfied with respect to an ERISA plan engaging in a principal transaction or a riskless principal transaction, the Adviser and Financial Institution would be unable to rely on the exemption for relief from ERISA’s prohibited transactions restrictions. An Adviser’s failure to comply with the exemption would result in a non-exempt prohibited transaction under ERISA section 406 and would likely constitute a fiduciary breach under ERISA section 404. As a result, a plan, plan participant or beneficiary would be able to sue under ERISA section 502(a)(2) or (3) to recover any loss in value to the plan (including the loss in value to an individual account), or to obtain disgorgement of any wrongful profits or unjust enrichment. In addition, the Secretary of Labor can enforce ERISA’s prohibited transaction and fiduciary duty provisions with respect to these ERISA plans, and an excise tax under the Code, as described above, applies. In this regard, under Section II(g)(5) of the exemption, the Financial Institution and Adviser may not rely on the exemption if, in any contract, instrument, or communication they disclaim any responsibility or liability for any responsibility, obligation, or duty under Title I of ERISA to the extent the disclaimer would be prohibited by ERISA section 410, waive or qualify the right of the Retirement Investor to bring or participate in a class action or other representative action in court in a dispute with the Adviser or Financial Institution, or require arbitration or mediation of individual claims in locations that are distant or that otherwise unreasonably limit the ability of the Retirement Investors to assert the claims safeguarded by this exemption. The exemption’s enforceability, and the potential for liability, is critical to ensuring adherence to the exemption’s stringent standards and protections, notwithstanding the competing pull of the conflicts of interest associated with principal transactions and riskless principal transactions. The Department expects claims of Retirement Investors regarding investments in ERISA plans to be brought under ERISA’s enforcement provisions, discussed above. In general, ERISA section 410 invalidates E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations instruments purporting to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under ERISA. Accordingly, provisions purporting to waive fiduciary obligations under ERISA serve only to mislead Retirement Investors about the scope of their rights. Additionally, the legislative intent of ERISA was, in part, to provide for ‘‘ready access to federal courts.’’ Accordingly, any recommended transaction covered by a contract or other instrument that waives or qualifies the right of the Retirement Investor to bring or participate in a class action or other representative action in court, will not be eligible for relief under this exemption. A number of comments were received on the contract requirement as it was proposed. The comments, and the Department’s responses, are discussed below. The Department notes that some of the commenters simply crossreferenced their comments, in the entirety, with respect to the same provisions in the proposed Best Interest Contract Exemption. Additionally, some commenters focused their comments solely on the Best Interest Contract Exemption. The Department determined it was important that the contract provisions in the Best Interest Contract Exemption be compatible with the contract provisions in this exemption, so that the two exemptions can easily be used together. For this reason, the Department considered all comments made on either exemption on a consolidated basis, and made corresponding changes in the two exemptions. For ease of use, the Department has included in this preamble the same general discussion of comments as in the Best Interest Contract Exemption, despite the fact that some comments discussed below were not made directly with respect to this exemption. In this regard, one commenter inquired as to whether the contract required in this exemption could be combined with the contract required by the Best Interest Contract Exemption, or whether two contracts would be needed. It was the Department’s intent in crafting this exemption that it could be used in connection with the Best Interest Contract Exemption, and it is the Department’s view that there need only be one contract. If parties wish to give themselves flexibility to engage in principal transactions and riskless principal transactions with Retirement Investors, they can include the contract provisions that are specific to principal transactions and riskless principal transactions and obtain the Retirement VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Investor’s consent to participate in such transactions. a. Contract Requirement Applicable to IRAs and Non-ERISA Plans A number of commenters took the position that the consumer protections afforded by the contract requirement are an essential feature of the exemption, particularly in the IRA market. Commenters indicated that enforceability is critical in the IRA market because of IRA owners’ lack of a statutory right to enforce prohibited transactions provisions. Commenters said that, in order to achieve the goal of providing meaningful new protections to Retirement Investors, the exemption must provide a mechanism by which Advisers and Financial Institutions can be held legally accountable for the retirement recommendations they make. Many other commenters, however, raised significant objections to the contract requirement. Commenters pointed to certain conditions of the exemption that they found ambiguous or subjective and indicated that these conditions could form the basis of class action lawsuits by disappointed investors. Some commenters said the contract requirement and associated litigation exposure will cause investment advice providers to cease serving Retirement Investors or provide only fee-based accounts that do not vary on the basis of the advice provided, resulting in the loss of services to retirement investors with smaller account balances. These commenters stated that investment advice fiduciaries would not risk the anticipated legal liability for Retirement Investors, or at least with respect to small accounts. Commenters also indicated that the SEC’s Temporary Rule 206(3)–3T already addresses the issues regarding principal transactions that the Department is attempting to address. In the final exemption, the Department retained the contract requirement with respect to IRAs and non-ERISA plans. The contractual commitment provides an administrable means of ensuring fiduciary conduct, eliminating ambiguity about the fiduciary nature of the relationship, and enforcing the exemption’s conditions, thereby assuring compliance. The existence of enforceable rights and remedies gives Financial Institutions and Advisers a powerful incentive to comply with the exemption’s standards, implement effective anti-conflict policies and procedures, and carefully police conflicts of interest. The enforceable contract gives clarity to the fiduciary nature of the undertaking, and ensures that Advisers and Financial PO 00000 Frm 00157 Fmt 4701 Sfmt 4700 21101 Institutions do not subordinate the interests of the Retirement Investor to their own competing financial interests. The contract effectively aligns the interests of Retirement Investor, Advisers, and the Financial Institution, and gives the Retirement Investor the means to redress injury when violations occur. Without a contract, the possible imposition of an excise tax provides an additional, but inadequate incentive to ensure compliance with the exemption’s standards-based approach. This is particularly true because imposition of the excise tax critically depends on fiduciaries’ self-reporting of violations, rather than independent investigations and litigation by the IRS. In contrast, contract enforcement does not rely on conflicted fiduciaries’ assessment of their own adherence to fiduciary norms or require the creation and expansion of a government enforcement apparatus. The contract provides an administrable way of ensuring adherence to fiduciary standards, broadly applicable to an enormous range of investments and advice relationships. The enforceability of the exemption’s provisions enables the Department to grant exemptive relief based upon broad protective standards rather than rely exclusively upon highly proscriptive conditions. In the context of this exemption, the risk of litigation and enforcement serves many of the same functions that it has for hundreds of years under the law of trust and agency. It gives fiduciaries a powerful incentive to adhere to broad, flexible, and protective standards applicable to principal transactions and riskless principal transactions by imposing liability and providing a remedy when fiduciaries fail to comply with those standards. In addition, a number of features of this final exemption, discussed more fully below, should temper commenters’ concerns about the risk of excessive litigation. In particular, the exemption permits Advisers and Financial Institutions to require mandatory arbitration of individual claims, so that claims that do not involve systemic abuse or entire classes of participants can be resolved outside of court. Similarly, the exemption permits waivers of the right to obtain punitive damages or rescission based on violation of the contract. In the Department’s view, make-whole compensatory relief is sufficient to incentivize compliance and redress injury caused by fiduciary misconduct. The Department has also clarified a number of the exemption’s conditions and simplified the disclosure and E:\FR\FM\08APR3.SGM 08APR3 21102 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 compliance obligations to facilitate adherence to the exemption’s terms. The core principles of the exemption are well-established under trust law, ERISA and the Code, and have a long history of interpretations in court. Moreover, the Impartial Conduct Standards are measured based on the circumstances existing at the time of the recommendation, not based on the ultimate performance of the investment with the benefit of hindsight. It is well settled as a legal matter that fiduciary advisers are not guarantors of the success of investments under ERISA or the Code, and this exemption does nothing to change that fact. Finally, the Department added provisions enabling Advisers and Financial Institutions to correct good faith errors in disclosure, without facing loss of the exemption. The Department did not rely solely on the approach in the SEC’s Temporary Rule 206(3)–3T, or another primarily disclosure-based approach, as suggested by some commenters. In the Department’s view, disclosure of conflicts is a necessary, but not sufficient, basis for relief in the context of fiduciary self-dealing involving taxfavored accounts. One commenter asked the Department to address the interaction of the contract cause of action and state securities laws. In this connection, the Department confirms that it is not the Department’s intent to preempt or supersede state securities law and enforcement, and the state securities laws remain subject to the ERISA section 514(b)(2)(A) savings clause. b. No Contract Requirement Applicable to ERISA Plans Under Section II(g) of the exemption, there is no contract requirement for transactions involving ERISA plans, but Financial Institutions and their Advisers must satisfy the conditions of Section II(b)–(e), including the conditions requiring written fiduciary acknowledgment, adherence to Impartial Conduct Standards, policies and procedures, and disclosures. The Department eliminated the proposed contract requirement with respect to ERISA plans in this final exemption in response to public comment on this issue. A number of commenters indicated that the contract requirement was unnecessary for ERISA plans due to the statutory framework that already provides enforcement rights to such plans, their participants and beneficiaries, and the Secretary of Labor. Some commenters additionally questioned the extent to which the contract provided additional rights or remedies, and whether state-law VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 contract claims would be pre-empted under ERISA’s pre-emption provisions. In the Department’s view, the requirement that a Financial Institution provide written acknowledgement of fiduciary status for itself and its Advisers provides protections in the ERISA plan context that are comparable to the contract requirement for IRAs and non-ERISA plans. As a result of the written acknowledgment of fiduciary status, the fiduciary nature of the relationship will be clear to the parties both at the time of the investment transaction, and in the event of subsequent disputes over the conduct of the Advisers or Financial Institutions. There will be far less cause for the parties to litigate disputes over fiduciary status, as opposed to the substance of the fiduciaries’ recommendations and conduct. 2. Contract Operational Issues—Section II(a) Section II(a) specifies the mechanics of entering into the contract and provides that the contract must be enforceable against the Financial Institution. In addition, the section indicates that the contract may be a master contract covering multiple recommendations, and that it may cover advice that was rendered prior to the execution of the contract as long as the contract is entered into prior to or at the same time as the execution of the recommended transaction. Section II(a)(1) further describes the methods for obtaining customer assent to the contract. For ‘‘new contracts,’’ the Retirement Investor’s assent must be demonstrated through a written or electronic signature. The exemption provides flexibility by permitting the contract terms to be set forth in a standalone document or in an investment advisory agreement, investment program agreement, account opening agreement, insurance or annuity contract or application, or similar document, or amendment thereto. For Retirement Investors with ‘‘existing contracts,’’ the exemption permits assent to be evidenced either by affirmative consent, as described above, or by a negative consent procedure. Under the negative consent procedure, the Financial Institution delivers a proposed contract amendment along with the disclosure required in Section II(e) to the Retirement Investor prior to January 1, 2018, and if the Retirement Investor does not terminate the amended contract within 30 days, the amended contract is effective. If the Retirement Investor does terminate the contract within that 30-day period, this PO 00000 Frm 00158 Fmt 4701 Sfmt 4700 exemption will provide relief for 14 days after the date on which the termination is received by the Financial Institution.21 An existing contract is defined in the exemption as ‘‘an investment advisory agreement, investment program agreement, account opening agreement, insurance contract, annuity contract, or similar agreement or contract that was executed before January 1, 2018 and remains in effect.’’ If the Financial Institution elects to use the negative consent procedure, it may deliver the proposed amendment by mail or electronically, but it may not impose any new contractual obligations, restrictions, or liabilities on the Retirement Investor by negative consent. Finally, Section II(a)(2) of the exemption requires the Financial Institution to maintain an electronic copy of the Retirement Investor’s contract on its Web site that is accessible by the Retirement Investor. This condition ensures that the Retirement Investor has ready access to the terms of the contract, and reinforces the exemption’s goals of clearly establishing the fiduciary status of the Adviser and Financial Institution and ensuring their adherence to the exemption’s conditions. Comments on specific contract operational issues are discussed below. a. Contract Timing As proposed, Section II(a) required that, ‘‘[p]rior to recommending that the plan, participant or beneficiary account, or IRA purchase, sell or hold the Asset, the Adviser and Financial Institution enter into a written contract with the Retirement Investor that incorporates the terms required by Section II(b)–(e).’’ A large number of commenters responded to various aspects of this proposed requirement. Many commenters objected to the timing of the contract requirement. They said that requiring execution of a contract ‘‘prior to’’ any recommendations would be contrary to existing industry practices. The commenters indicated that preliminary discussions may evolve into recommendations before a Retirement Investor has decided to work with a particular Adviser and Financial Institution. Requiring a contract upfront 21 Alternatively, for purposes of this exemption, Advisers and Financial Institutions can provide the contractual terms required by the exemption and permit the Retirement Investor to specifically decline to authorize principal transactions and riskless principal transactions within 30 days but continue the existing contract. Of course, to the extent prohibited transaction relief is needed for transactions under the existing contract, the Adviser and Financial Institution would need to comply with another exemption. E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations could chill such preliminary discussions, unduly complicate the relationship between the Adviser and the Retirement Investor, and interfere with an investor’s ability to shop around. Many commenters suggested that it would be better to time the requirement so that the contract would have to be entered into prior to the execution of the actual principal transaction, or even later, rather than before any advice was rendered. While some other commenters supported the proposed timing, noting the benefit of allowing Retirement Investors the chance to carefully review the contract prior to engaging in transactions, several commenters that strongly supported the contract requirement agreed that the timing could be adjusted without loss of protection to the Retirement Investor. In the Department’s view, the precise timing of the contract is not critical to the exemption, provided that the parties enter into a contract covering the advice. The Department did not intend to chill developing advice relationships or limit investors’ ability to shop around. Therefore, the Department adjusted the exemption on this point by deleting the proposed requirement that the contract be entered into prior to the advice recommendation. Instead, the exemption generally provides that the advice must be subject to an enforceable written contract entered into prior to or at the same time as the execution of the recommended transaction. However, in order for the exemption to be available to recommendations made prior to the contract’s formation, the contract’s terms must cover the prior recommendations. A few commenters suggested that the Department require the contract to be a separate document, not combined with any other document. However, other commenters requested that the Department allow Financial Institutions to incorporate the contract terms into other account documents. While the Department believes the contract is critical to IRA and non-ERISA plan investors, the Department recognizes the need for flexibility in its implementation. Therefore, the exemption contemplates that the contract may be incorporated into other documents to the extent desired by the Financial Institution. Additionally, as requested by commenters, the Department confirms that the contract requirement may be satisfied through a master contract covering multiple recommendations and does not require execution prior to each additional recommendation. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 b. Contract Parties A number of commenters questioned the necessity of the proposed requirement that Advisers be parties to the contract. These commenters indicated that the proposed requirement posed significant logistical challenges. For example, commenters stated that Advisers often work in teams and it would be difficult to obtain signatures from all such Advisers. Similarly, if call center representatives made recommendations that include principal transactions and riskless principal transactions, it could be hard to cover them under a contract. Over the course of a Retirement Investor’s relationship with a Financial Institution, he or she could receive advice from a number of persons. Requiring that each such person execute a contract could prove difficult and unwieldy. Based upon these objections, the Department deleted the requirement that individual Advisers be parties to the contract. The Financial Institution must be a party to the contract and take responsibility for satisfying the exemption’s conditions, including the obligation to have policies and procedures reasonably and prudently designed to ensure that individual Advisers adhere to the Impartial Conduct Standards, and the obligation to insulate the Adviser from incentives to violate the Best Interest standard. Such Advisers include call center representatives who provide investment advice within the meaning of the Regulation. Some commenters suggested that the Department provide additional flexibility and allow the individual Adviser to be obligated under the contract instead of the Financial Institution. The Department has not adopted that suggestion. To ensure operation of the exemption as intended, the Financial Institution should be a party to the contract. The supervisory responsibility and liability of the Financial Institution is important to the exemption’s protections. In particular, the exemption contemplates that the Financial Institution will adopt and monitor stringent anti-conflict policies and procedures; avoid financial incentives that undermine the Impartial Conduct standards; and take appropriate measures to ensure that it and its representatives adhere to the exemption’s conditions. The contract provides both a mechanism for imposing these obligations on the Financial Institution and creates a powerful incentive for the Financial Institution to take the obligations seriously in the management and PO 00000 Frm 00159 Fmt 4701 Sfmt 4700 21103 supervision of investment recommendations. c. Contract Signatures Section II(a) of the exemption provides that the contract must be enforceable against the Financial Institution. As long as that is the case, the Financial Institution is not required to sign the contract. Section II(a) of the exemption further describes the methods through which customer assent may be achieved, and reflects commenters’ requests for greater specificity on this point. With respect to new contracts, a few commenters asked the Department to confirm that electronic execution by the Retirement Investor is sufficient. Another commenter asked about telephone assent. In the final exemption, the Department specifically permits electronic execution as a form of customer assent. The Department has not permitted telephone assent, however, because of the potential issues of proof regarding the existence and terms of a contract executed in that manner. It is the Department’s goal that Retirement Investors obtain clear evidence of the contract terms and their applicability to the Retirement Investor’s own account or contract. The exemption will best serve its purpose if the contractual commitments are clear to all the parties, and if ancillary disputes about the fiduciary nature of the advice relationship are avoided. For this same reason, the exemption requires that a copy of the applicable contract be maintained on a Web site accessible to the Retirement Investor. Commenters also asked for the ability to use a negative consent procedure with respect to existing customers to avoid the expense and difficulty associated with obtaining a large number of client signatures. The Department adjusted the exemption on this point to permit amendment of existing contracts by negative consent, as discussed above. As this approach will still result in the Retirement Investor receiving clear evidence of the contract terms and their applicability to the Retirement Investor’s own account or contract, the Department concurred with commenters on its use. Treating the Retirement Investor’s silence as consent after 30 days provides the Retirement Investor a reasonable opportunity to review the new terms and to reject them. The Financial Institution may not use the negative consent procedure, however, to impose new obligations, restrictions or liabilities on the Retirement Investor in connection with this exemption. Any attempt by the Financial Institution to E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21104 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations impose additional obligations, restrictions or liabilities on the Retirement Investor must receive affirmative consent from the Retirement Investor, and cannot violate Section II(f). A number of commenters also asked that the exemption authorize Financial Institutions to satisfy the contract requirement for all Retirement Investors—including new customers after the January 1, 2018—through unilateral contracts or implied or negative consent. Some commenters suggested that the Department should not require a contract at all, but only a ‘‘customer bill of rights’’ or similar disclosure, without any additional signature requirement. Some commenters suggested that the requirement of obtaining signatures could delay execution of time sensitive investment strategies. Although the final exemption accommodates a wide variety of concerns regarding contract operational issues, the Department did not adopt the alternative approaches suggested by some commenters, such as merely requiring delivery of a customer bill of rights, broader reliance on a unilateral contract approach, or increased reliance on negative consent. The Department intends that Retirement Investors that are new customers of the Financial Institution should enter into an enforceable contract under Section II(a)(1)(i). Consistent with the Department’s goal that Retirement Investors obtain clear evidence of the contract terms and their applicability to the Retirement Investor’s own account or contract, the exemption limits the negative consent option to existing customers as a form of transitional relief, so that Financial Institutions can avoid the burdens associated with obtaining signatures from a large number of already-existing customers. Apart from this transitional relief, the Department does not believe it is appropriate to dispense with the clarity, enforceability and legal protections associated with an affirmative contract. Contracts are commonplace in a wide range of commercial transactions occurring in person, on the web, and elsewhere. The Department has facilitated the process by providing that Financial Institutions can incorporate the contract terms into commonplace account opening or similar documents that they already use; by permitting electronic signatures; and by revising the timing rules, so that the contract’s execution can follow the provision of advice, as long as it precedes or occurs at the same time as the execution of the recommended transaction. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 3. Fiduciary Acknowledgment—Section II(b) Section II(b) of the exemption requires the Financial Institution to affirmatively state in writing that the Financial Institution and the Adviser(s) act as fiduciaries under ERISA or the Code, or both, with respect to any investment advice regarding principal transactions and riskless principal transactions provided by the Financial Institution or the Adviser subject to the contract or, in the case of an ERISA plan, with respect to any investment advice regarding the principal transactions and riskless principal transactions between the Financial Institution and the Plan or participant or beneficiary account. With respect to IRAs and non-ERISA plans, if this acknowledgment of fiduciary status does not appear in a contract with a Retirement Investor, the exemption is not satisfied with respect to transactions involving that Retirement Investor. With respect to ERISA plans, this acknowledgment must be provided to the Retirement Investor prior to or at the same time as the execution of the recommended transaction, but not as part of a contract. This fiduciary acknowledgment is critical to ensuring clarity and certainty with respect to fiduciary status of both the Adviser and Financial Institution under ERISA and the Code with respect to that advice. The fiduciary acknowledgment provision received significant support from some commenters. Commenters described it as a necessary protection and noted that it would clarify the obligations of the Adviser. One commenter said that facilitating proof of fiduciary status should enhance investors’ ability to obtain a remedy for Adviser misconduct in arbitration by eliminating ancillary litigation over fiduciary status. Rather than litigate over fiduciary status, the fiduciary acknowledgment would help ensure that the proceedings focused on the Advisers’ compliance with fundamental fiduciary norms. Some commenters opposed the fiduciary acknowledgment requirement in the proposal, as applicable to Financial Institutions, on the basis that it could force Financial Institutions to take on fiduciary responsibilities, even if they would not otherwise be functional fiduciaries under ERISA or the Code. The commenters pointed out that under the proposed Regulation, the acknowledgment of fiduciary status would have been a factor in imposing fiduciary status on a party. Therefore, Financial Institutions could become fiduciaries by virtue of the fiduciary PO 00000 Frm 00160 Fmt 4701 Sfmt 4700 acknowledgment. To address these concerns, a few commenters suggested language under which a Financial Institution would only be considered a fiduciary to the extent that it is ‘‘an affiliate of the Adviser within the meaning of 29 CFR 2510.3–21(f)(7) that, with the Adviser, functions as a fiduciary.’’ The Department has not adjusted the exemption as these commenters requested. The exemption requires as a condition of relief that a sponsoring Financial Institution accept fiduciary responsibility for the recommendations of its Adviser(s). The Financial Institution’s role in supervising individual Advisers and overseeing their adherence to the Impartial Conduct Standards is a key safeguard of the exemption. The exemption’s success critically depends on the Financial Institution’s careful implementation of anti-conflict policies and procedures, avoidance of Adviser incentives to violate the Impartial Conduct Standards and broad oversight of Advisers. Accordingly, Financial Institutions that wish to engage in principal transactions and riskless principal transactions that would otherwise be prohibited under ERISA and the Code must agree to take on these responsibilities as a condition of relief under the exemption. To the extent Financial Institutions do not wish to take on this role with their associated responsibilities and liabilities, they may structure their operations to avoid prohibited transactions and the resultant need of the exemption. Other commenters expressed the view that the fiduciary acknowledgement would potentially require broker-dealers to satisfy the requirements of the Investment Advisers Act of 1940. As described by commenters, the Act does not require broker-dealers to register as investment advisers if they provide advice that is solely incidental to their brokerage services. Commenters expressed concern that acknowledging fiduciary status and providing advice in satisfaction of the Impartial Conduct Standards could call into question whether the advice provided was solely incidental. The Department does not, however, require the Adviser or Financial Institution to acknowledge fiduciary status under the securities laws, but rather under ERISA or the Code or both. Neither does the Department require Advisers to agree to provide investment advice on an ongoing, rather than transactional, basis. An Adviser’s status as an ERISA fiduciary is not dispositive of its obligations under the securities laws, and compliance with the E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 exemption does not trigger an automatic loss of the broker-dealer exception under the separate requirements of those laws. A broker-dealer who provides investment advice under the Regulation is an ERISA fiduciary; acknowledgment of ERISA fiduciary status would not, by itself, cause the Adviser to lose the broker-dealer exception. Under the Regulation and this exemption, the primary import of fiduciary status is that the broker has to act in the customer’s Best Interest when making recommendations; seek to obtain the best execution reasonably available under the circumstances with respect to the transaction; and refrain from making misleading statements. Certainly, nothing in the securities laws precludes brokers from adhering to these basic standards, or forbids them from working for Financial Institutions that implement appropriate policies and procedures to ensure that these standards are met. The Department changed the fiduciary acknowledgment provision in response to several comments requesting revisions to clarify the required extent of the fiduciary acknowledgment. Accordingly, the Department has clarified that the acknowledgment can be limited to investment recommendations subject to the contract or, in the case of an ERISA plan, any investment recommendations regarding the plan or beneficiary or participant account. As discussed in more detail below, the exemption (including the required fiduciary acknowledgment) does not in and of itself, impose an ongoing duty to monitor on the Adviser and Financial Institution. However, there may be some investments which cannot be prudently recommended for purchase to individual Retirement Investors, in the first place, without a mechanism in place for the ongoing monitoring of the investment. 4. Impartial Conduct Standards— Section II(c) Section II(c) of the exemption requires that the Adviser and Financial Institution comply with fundamental Impartial Conduct Standards. Generally stated, the Impartial Conduct Standards require that Advisers and Financial Institutions provide investment advice regarding the principal transaction or riskless principal transaction that is in the Retirement Investor’s Best Interest, seek to obtain the best execution reasonably available under the circumstances with respect to the transaction, and not make misleading statements to the Retirement Investor about the recommended transaction and VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Material Conflicts of Interest. As defined in the exemption, a Financial Institution and Adviser act in the Best Interest of a Retirement Investor when they provide investment advice that reflects ‘‘the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution, any Affiliate or other party.’’ The Impartial Conduct Standards represent fundamental obligations of fair dealing and fiduciary conduct. The concepts of prudence, undivided loyalty and reasonable compensation are all deeply rooted in ERISA and the common law of agency and trusts.22 These longstanding concepts of law and equity were developed in significant part to deal with the issues that arise when agents and persons in a position of trust have conflicting loyalties, and accordingly, are well-suited to the problems posed by conflicted investment advice. The phrase ‘‘without regard to’’ is a concise expression of ERISA’s duty of loyalty, as expressed in section 404(a)(1)(A) of ERISA and applied in the context of advice. It is consistent with the formulation stated in the common law, and it is consistent with the language used by Congress in Section 913(g)(1) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act),23 and cited in the Staff of the U.S. Securities and Exchange Commission ‘‘Study on Investment Advisers and Broker-Dealers as Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act’’ (Jan. 2011) (SEC staff Dodd-Frank Study).24 Under ERISA section 408(a) and Code section 4975(c)(2), the Department 22 See generally ERISA sections 404(a), 408(b)(2); Restatement (Third) of Trusts section 78 (2007), and Restatement (Third) of Agency section 8.01. 23 Section 913(g) of the Dodd-Frank Act governs ‘‘Standard of Conduct’’ and subsection (1) provides that ‘‘The Commission may promulgate rules to provide that the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.’’ 24 SEC Staff Study on Investment Advisers and Broker-Dealers, January 2011, available at https:// www.sec.gov/news/studies/2011/913studyfinal.pdf, pp. 109–110. PO 00000 Frm 00161 Fmt 4701 Sfmt 4700 21105 cannot grant an exemption unless it first finds that the exemption is administratively feasible, in the interests of plans and their participants and beneficiaries and IRA owners, and protective of the rights of participants and beneficiaries of plans and IRA owners. An exemption permitting transactions that violate the Impartial Conduct Standards would fail these standards. The Impartial Conduct Standards are conditions of the exemption for the provision of advice with respect to all Retirement Investors. For advice to Retirement Investors in IRAs and nonERISA plans, the Impartial Conduct Standards must also be included as contractual commitments on the part of the Financial Institution and its Advisers. As noted above, there is no contract requirement for advice with respect Retirement Investors in ERISA plans. Comments on each of the Impartial Conduct Standards are discussed below. Additionally, in response to commenters’ assertion that the exemption is not administratively feasible due to uncertainty regarding some terms and requests for additional clarity, the Department has clarified some key terms in the text and provides additional interpretive guidance in the preamble discussion that follows. Finally, the Department discusses comments on the treatment of the Impartial Conduct Standards as both exemption conditions for all Retirement Investors as well as contractual representations with respect to IRAs and other non-ERISA Plans. a. Best Interest Standard Under Section II(c)(1), the Financial Institution must state that it and its Advisers will comply with a Best Interest standard when providing investment advice to the Retirement Investor with respect to principal transactions and riskless principal transactions, and, in fact, adhere to the standard. Advice in the Retirement Investor’s Best Interest means advice that, at the time of the recommendation: reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, or other party. The Best Interest standard set forth in the exemption is based on longstanding E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21106 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations concepts derived from ERISA and the law of trusts. It is meant to express the concept, set forth in ERISA section 404, that a fiduciary is required to act ‘‘solely in the interest of the participants . . . with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.’’ Similarly, both ERISA section 404(a)(1)(A) and the trust-law duty of loyalty require fiduciaries to put the interests of trust beneficiaries first, without regard to the fiduciaries’ own self-interest. Under this standard, for example, an Adviser, in choosing between two investments, could not select an investment because it is better for the Adviser’s or Financial Institution’s bottom line, even though it is a worse choice for the Retirement Investor. A wide range of commenters indicated support for a broad Best Interest standard. Some comments indicated that the Best Interest standard is consistent with the way Advisers provide investment advice to clients today. However, a number of these commenters expressed misgivings as to the definition used in the proposed exemption, in particular, the ‘‘without regard to’’ formulation. The commenters indicated uncertainty as to the meaning of the phrase, including whether it effectively precluded an Adviser from receiving compensation if a particular investment would generate higher Adviser compensation. Other commenters asked the Department to use a different definition of Best Interest, or simply use the exact language from ERISA’s section 404 duty of loyalty. Others suggested definitional approaches that would require that the Adviser and Financial Institution ‘‘not subordinate’’ their customers’ interests to their own interests, or that the Adviser and Financial Institution ‘‘put their customers’ interests ahead of their own interests,’’ or similar constructs. FINRA suggested that the federal securities laws should form the foundation of the Best Interest standard. Specifically, FINRA urged that the Best Interest definition in the exemption incorporate the suitability standard applicable to investment advisers and broker dealers under federal securities laws. According to FINRA, this would facilitate customer enforcement of the Best Interest standard by providing adjudicators with a well-established basis on which to find a violation. Other commenters found the Best Interest standard to be an appropriate statement of the obligations of a VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 fiduciary investment advice provider and believed it would provide concrete protections against conflicted recommendations. These commenters asked the Department to maintain the Best Interest definition as proposed. One commenter wrote that the term ‘‘best interest’’ is commonly used in connection with a fiduciary’s duty of loyalty and cautioned the Department against creating an exemption that failed to include the duty of loyalty. Others urged the Department to avoid definitional changes that would reduce current protections to Retirement Investors. Some commenters also noted that the ‘‘without regard to’’ language is consistent with the recommended standard in the SEC staff Dodd-Frank Study, and suggested that it has added benefit of potentially harmonizing with a future securities law standard for broker-dealers. In the context of principal transactions, one commenter suggested that the Department make clear that both the advice and the execution of the transaction must be in the Retirement Investor’s Best Interest. The Department agrees that the execution of the transaction is an important concern, and has incorporated in Section II(c)(2) of the exemption, a provision requiring Financial Institutions that are FINRA members to agree that they and their Advisers and Financial Institution will comply with the terms of FINRA rule 5310 (Best Execution and Interpositioning). The final exemption retains the Best Interest definition as proposed, with minor adjustments. The first prong of the standard was revised to more closely track the statutory language of ERISA section 404(a), and, is consistent with the Department’s intent to hold investment advice fiduciaries to a prudent investment professional standard. Accordingly, the definition of Best Interest now requires advice that ‘‘reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor . . .’’ The exemption adopts the second prong of the proposed definition, ‘‘without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate or other party,’’ without change. The Department continues to believe that the ‘‘without regard to’’ language sets forth the appropriate, protective standard under which a PO 00000 Frm 00162 Fmt 4701 Sfmt 4700 fiduciary investment adviser should act. The standard ensures that the advice will not be tainted by self-interest. Under this language, an Adviser and Financial Institution must make a recommendation with respect to the principal transaction or riskless principal transaction without considering their own financial or other interests, or those of their Affiliates, or others. They may not recommend such a transaction on the basis that it pays them more, or otherwise benefits them more than a transaction conducted on an agency basis. Many of the alternative approaches suggested by commenters pose their own ambiguities and interpretive challenges, and lower standards run the risk of undermining this regulatory initiative’s goal of reducing the impact of conflicts of interest on Retirement Investors. The Department has not specifically incorporated the suitability obligation as an element of the Best Interest standard, as suggested by FINRA but many aspects of suitability are also elements of the Best Interest standard. An investment recommendation that is not suitable under the securities laws would not meet the Best Interest standard. Under FINRA’s rule 2111(a) on suitability, broker-dealers ‘‘must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.’’ The text of rule 2111(a), however, does not do any of the following: Reference a best interest standard, clearly require brokers to put their client’s interests ahead of their own, expressly prohibit the selection of the least suitable (but more remunerative) of available investments, or require them to take the kind of measures to avoid or mitigate conflicts of interests that are required as conditions of this exemption. The Department recognizes that FINRA issued guidance on rule 2111 in which it explains that ‘‘in interpreting the suitability rule, numerous cases explicitly state that a broker’s recommendations must be consistent with his customers’ best interests,’’ and provided examples of conduct that would be prohibited under this standard, including conduct that this exemption would not allow.25 The guidance goes on to state that ‘‘[t]he suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests.’’ The Department, however is reluctant to adopt as an 25 FINRA E:\FR\FM\08APR3.SGM Regulatory Notice 12–25, p. 3 (2012). 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations express standard such guidance, which has not been formalized as a clear rule and that, in any case, may be subject to change. Additionally, FINRA’s suitability rule may be subject to interpretations which could conflict with interpretations by the Department, and the cases cited in the FINRA guidance, as read by the Department, involved egregious fact patterns that one would have thought violated the suitability standard even without reference to the customer’s best interest. Moreover, suitability under SEC practice differs somewhat from the FINRA approach. According to the SEC staff Dodd-Frank Study, the SEC requirements are based on the anti-fraud provisions of the Securities Act Section 17(a), the Exchange Act Section 10(b) and Rule 10b–5 thereunder.26 As a general matter, SEC Rule 10b–5 prohibits any person, directly or indirectly, from: (a) Employing any device, scheme, or artifice to defraud; (b) making untrue statements of material fact or omitting to state a material fact necessary in order to make the statements made, in the light of the circumstances, not misleading; or (c) engaging in any act or practice or course of business which operates or that would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security. FINRA does not require scienter, but the weight of authority holds that violations of the Self-Regulatory Organization rules, standing alone, do not give right to a private cause of action. Courts, however, allow private claims for violations of SEC Rule 10b–5 for fraud claims, including, among others, unsuitable recommendations. The private plaintiff must establish that the broker’s unsuitable recommendation involved a misrepresentation (or material omission) made with scienter. Accordingly, after review of the issue, the Department has decided not to accept the comment. The Department has concluded that its articulation of a clear loyalty standard within the exemption, rather than by reference to the FINRA guidance, will provide clarity and certainty to investors, and better protect their interests. The Best Interest standard, as set forth in the exemption, is intended to effectively incorporate the objective standards of care and undivided loyalty that have been applied under ERISA for more than forty years. Under these objective standards, the Adviser must adhere to a professional standard of care in making investment recommendations regarding principal transactions and 26 SEC staff Dodd-Frank Study at 61. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 riskless principal transactions that are in the Retirement Investor’s Best Interest. The Adviser may not base his or her recommendations on the Adviser’s own financial interest in the transaction. Nor may the Adviser recommend a principal transaction or riskless principal transaction, unless it meets the objective prudent person standard of care. Additionally, the duties of loyalty and prudence embodied in ERISA are objective obligations that do not require proof of fraud or misrepresentation, and full disclosure is not a defense to making an imprudent recommendation or favoring one’s own interests at the Retirement Investor’s expense. A few commenters also questioned the requirement in the Best Interest standard that recommendations be made without regard to the interests of the Adviser, Financial Institution, any Affiliate, or other party. The commenters indicated they did not know the purpose of the reference to ‘‘other party’’ and asked that it be deleted. The Department intends the reference to make clear that an Adviser and Financial Institution operating within the Impartial Conduct Standards should not take into account the interests of any party other than the Retirement Investor—whether the other party is related to the Adviser or Financial Institution or not—in making a recommendation regarding a principal transaction or riskless principal transaction. For example, an entity that may be unrelated to the Adviser or Financial Institution but could still constitute an ‘‘other party,’’ for these purposes, is the manufacturer of the investment product being recommended. Other commenters asked for confirmation that the Best Interest standard is applied based on the facts and circumstances as they existed at the time of the recommendation, and not based on hindsight. Consistent with the well-established legal principles that exist under ERISA today, the Department confirms that the Best Interest standard is not a hindsight standard, but rather is based on the facts as they existed at the time of the recommendation. Thus, the courts have evaluated the prudence of a fiduciary’s actions under ERISA by focusing on the process the fiduciary used to reach its determination or recommendation— whether the fiduciary, ‘‘at the time they engaged in the challenged transactions, employed the proper procedures to investigate the merits of the investment PO 00000 Frm 00163 Fmt 4701 Sfmt 4700 21107 and to structure the investment.’’ 27 The standard does not measure compliance by reference to how investments subsequently performed or turn Advisers and Financial Institutions into guarantors of investment performance, even though they gave advice that was prudent and loyal at the time of transaction.28 This is not to suggest that the ERISA section 404 prudence standard, or Best Interest standard, are solely procedural standards. Thus, the prudence standard, as incorporated in the Best Interest standard, is an objective standard of care that requires investment advice fiduciaries to investigate and evaluate investments, make recommendations, and exercise sound judgment in the same way that knowledgeable and impartial professionals would. ‘‘[T]his is not a search for subjective good faith— a pure heart and an empty head are not enough.’’ 29 Whether or not the fiduciary is actually familiar with the sound investment principles necessary to make particular recommendations, the fiduciary must adhere to an objective professional standard. Additionally, fiduciaries are held to a particularly stringent standard of prudence when they have a conflict of interest.30 For this reason, the Department declines to provide a safe harbor based on ‘‘procedural prudence’’ as requested by a commenter. The Department additionally confirms its intent that the phrase ‘‘without regard to’’ be given the same meaning as the language in ERISA section 404 that requires a fiduciary to act ‘‘solely in the interest of’’ participants and 27 Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983). 28 One commenter requested an adjustment to the ‘‘prudence’’ component of the Best Interest standard, under which the standard would be that of a ‘‘prudent person serving clients with similar retirement needs and offering a similar array of products.’’ In this way, the commenter sought to accommodate varying perspectives and opinions on particular investment products and business practices. The Department disagrees with the comment, which could be read as qualifying the stringency of the prudence obligation based on the Financial Institution’s or Adviser’s independent decisions on which products to offer, rather than on the needs of the particular Retirement Investor. Therefore, the Department did not adopt this suggestion. 29 Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983), cert. denied, 467 U.S. 1251 (1984); see also DiFelice v. U.S. Airways, Inc., 497 F.3d 410, 418 (4th Cir. 2007) (‘‘Good faith does not provide a defense to a claim of a breach of these fiduciary duties; ‘a pure heart and an empty head are not enough.’’’). 30 Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982) (‘‘the[] decisions [of the fiduciary] must be made with an eye single to the interests of the participants and beneficiaries’’); see also Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 298 (5th Cir. 2000); Leigh v. Engle, 727 F.2d 113, 126 (7th Cir. 1984). E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21108 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations beneficiaries, as such standard has been interpreted by the Department and the courts. Therefore, the standard would not, as some commenters suggested, foreclose the Adviser and Financial Institution from being paid. The Department confirms that the standard does not preclude the Financial Institution from receiving reasonable compensation or from recouping the cost of obtaining and carrying the security, assuming the investment remains prudent when all its costs are considered. In response to commenter concerns, the Department also confirms that the Best Interest standard does not impose an unattainable obligation on Advisers and Financial Institutions to somehow identify the single ‘‘best’’ investment for the Retirement Investor out of all the investments in the national or international marketplace, assuming such advice or management were even possible. Instead, as discussed above, the Best Interest standard set out in the exemption, incorporates two fundamental and well-established fiduciary obligations: the duties of prudence and loyalty. Thus, the fiduciary’s obligation under the Best Interest standard is to give advice or acquire or dispose of investments in a manner that adheres to professional standards of prudence, and to put the Retirement Investor’s financial interests in the driver’s seat, rather than the competing interests of the Adviser or other parties. Finally, in response to questions regarding the extent to which this Best Interest standard or other provisions of the exemption impose an ongoing monitoring obligation on Advisers or Financial Institutions, the Department has added specific language in Section II(e) regarding monitoring. The text does not impose a monitoring requirement, but instead requires clarity. As suggested by FINRA, Section II(e) requires Advisers and Financial Institutions to disclose whether or not they will monitor the Retirement Investor’s investments and alert the Retirement Investor to any recommended changes to those investments and, if so, the frequency with which the monitoring will occur and the reasons for which the Retirement Investor will be alerted. This is consistent with the Department’s interpretation of an investment advice fiduciary’s monitoring responsibility as articulated in the preamble to the Regulation. The terms of the contract or disclosure along with other representations, agreements, or understandings between the Adviser, VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Financial Institution and Retirement Investor, will govern whether the nature of the relationship between the parties is ongoing or not. The preamble to the proposed Best Interest Contract Exemption stated that adherence to a Best Interest standard did not mandate an ongoing or long-term relationship, but instead left the determination of whether to enter into such a relationship to the parties.31 This exemption builds upon this and requires that the contract clearly state the nature of the relationship and whether there is any duty to monitor on the part of the Adviser or Financial Institution. Whether the Adviser and Financial Institution, in fact, have an obligation to monitor the investment and provide long-term advice depends on the parties’ reasonable understandings, arrangements, and agreements. b. Best Execution Section II(c)(2) of the exemption requires that the Adviser and Financial Institution seek to obtain the best execution reasonably available under the circumstances with respect to the principal transaction or riskless principal transaction with the plan, participant or beneficiary account or IRA. Section II(c)(2)(i) further provides that Financial Institutions that are FINRA members may satisfy Section II(c)(2) by complying with the terms of FINRA rules 2121 (Fair Prices and Commissions) and 5310 (Best Execution and Interpositioning), or any successor rules in effect at the time of the transaction,32 as interpreted by FINRA, with respect to the principal transaction or riskless principal transaction. This provision is revised from the proposal, which provided that the purchase or sales price could not be unreasonable under the circumstances. Commenters on the proposal indicated that they were uncertain as to what an unreasonable price would be and requested additional clarification of the rule. Further, some commenters indicated that FINRA rule 2121 (Fair Prices and Commissions) should be incorporated in the alternative. According to FINRA, rule 2121 ‘‘prohibits a broker-dealer from entering into a transaction with a customer ‘at any price’ that is not reasonably related to the current market 31 80 FR 21969 (Apr. 20, 2015). to the extent FINRA rules 2121 (Fair Prices and Commissions) or 5310 (Best Execution and Interpositioning) are amended, the Adviser and Financial Institution must comply with the requirements that are in effect at the time the transaction occurs. 32 Accordingly, PO 00000 Frm 00164 Fmt 4701 Sfmt 4700 price of the security.’’ FINRA additionally recommended that the Department incorporate FINRA rule 5310 (Best Execution and Interpositioning) instead of its proposed two-quote requirement (discussed below). According to FINRA: [Rule 5310] uses a ‘‘facts and circumstances’’ analysis by requiring that a firm dedicate reasonable diligence to ascertain the best market for the security and to buy or sell in such market so that the price to the customer is as favorable as possible under the prevailing market conditions. A key determinant in assessing whether a firm has met this reasonable diligence standard is the character of the market for the security itself, which includes an analysis of price, volatility and relative liquidity. [The] Rule . . . also addresses instances in which there is limited quotation or pricing information available. The rule requires a broker-dealer to have written policies and procedures that address how the firm will determine the best inter-dealer market for such a security in the absence of pricing information or multiple quotations and to document its compliance with those policies and procedures. After consideration of the comments received, the Department revised the proposed condition to focus on best execution, rather than an unreasonable price. The Department determined that a requirement that Advisers and Financial Institutions seek to obtain the best execution reasonably available under the circumstances with respect to the transaction, particularly as articulated by FINRA in rule 5310, would provide protections that are comparable to the Department’s proposed condition but that are more familiar to the parties relying on the exemption. The Department specifically incorporated FINRA rules 2121 and 5310 for FINRA members, as a method of satisfying this requirement, as suggested by some commenters. For Advisers and Financial Institutions that are not FINRA members, the best execution obligation under the exemption is satisfied if the Adviser and Financial Institution satisfies the best execution obligation as interpreted by their functional regulator. However, to the extent non-FINRA members wish for additional certainty as to their compliance obligations under this exemption, they may comply with the provisions of FINRA rules 2121 and 5310 to satisfy Section II(c)(2). Under Section II(c)(2)(ii), if the Department expands the scope of this exemption to include additional principal traded assets by individual exemption,33 the Department may 33 See E:\FR\FM\08APR3.SGM Section VI(j)(1)(iv). 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 identify specific alternative best execution and fair pricing requirements imposed by another regulator or selfregulatory organization that must be complied with. This would potentially permit, for example, Financial Institutions to cite specific requirements of the Municipal Securities Rulemaking Board, if municipal securities become covered under the exemption. c. Misleading Statements The final Impartial Conduct Standard, set forth in Section II(c)(3), requires that statements by the Financial Institution and its Advisers to the Retirement Investor about the recommended transaction, fees and compensation, Material Conflicts of Interest, and any other matters relevant to a Retirement Investor’s investment decision to engage in a principal transaction or a riskless principal transaction, may not be materially misleading at the time they are made. In response to commenters, the Department adjusted the text to clarify that the standard is measured at the time of the representations, i.e., the statements must not be misleading ‘‘at the time they are made.’’ Similarly, the Department added a materiality standard in response to comments. The Department did not accept certain other comments, however. One commenter requested that the Department add a qualifier providing that the standard is violated only if the statement was ‘‘reasonably relied’’ on by the Retirement Investor. The Department rejected the comment. The Department’s aim is to ensure that Financial Institutions and Advisors uniformly adhere to the Impartial Conduct Standards, including the obligation to avoid materially misleading statements, when they give advice. Whether a Retirement Investor relied on a particular statement may be relevant to the question of damages in subsequent arbitration or court proceedings, but it is not and should not be relevant to the question of whether the fiduciary violated the exemption’s standards in the first place. Moreover, inclusion of a reasonable reliance standard runs the risk of inviting boilerplate disclaimers of reliance in contracts and disclosure documents precisely so the Adviser can assert that any reliance is unreasonable. One commenter asked the Department to require only that the Adviser ‘‘reasonably believe’’ the statements are not misleading. The Department is concerned that this standard too could undermine the protections of this condition, by requiring Retirement Investors or the Department to prove the Adviser’s actual belief rather than VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 focusing on whether the statement is objectively misleading. However, to address commenters’ concerns about the risks of engaging in a prohibited transaction, as noted above, the Department has clarified that the standard is measured at the time of the representations and has added a materiality standard. The Department believes that Retirement Investors are best served by statements and representations that are free from material misstatements. Financial Institutions and Advisers best avoid liability—and best promote the interests of Retirement Investors—by ensuring that accurate communications are a consistent standard in all their interactions with their customers. A commenter suggested that the Department adopt FINRA’s ‘‘Frequently Asked Questions regarding Rule 2210’’ in this connection.34 FINRA’s rule 2210, Communications with the Public, sets forth a number of procedural rules and standards that are designed to, among other things, prevent broker-dealer communications from being misleading. The Department agrees that adherence to FINRA’s standards can promote materially accurate communications, and certainly believes that Financial Institutions and Advisers should pay careful attention to such guidance documents. After review of the rule and FAQs, however, the Department declines to simply adopt FINRA’s guidance, which addresses written communications, since the condition of the exemption is broader in this respect. In the Department’s view, the meaning of the standard is clear, and is already part of a plan fiduciary’s obligations under ERISA. If, however, issues arise in implementation of the exemption, the Department will consider requests for additional guidance. d. Contractual Representation Versus Exemption Condition Commenters expressed a variety of views on whether violations of the Impartial Conduct Standards with respect to advice regarding principal transactions to Retirement Investors regarding IRAs and non-ERISA plans should result in loss of the exemption, violation of the contract, or both.35 Some commenters objected to the incorporation of the Impartial Conduct Standards as contract terms, generally, on the basis that the requirement would 34 Currently available at http://www.finra.org/ industry/finra-rule-2210-questions-and-answers. 35 Commenters also asserted that the Department did not have the authority to condition the exemption on the Impartial Conduct Standards. Comments on the Department’s jurisdiction are discussed in a separate Section D. of this preamble. PO 00000 Frm 00165 Fmt 4701 Sfmt 4700 21109 contribute to litigation risk. Some commenters preferred that the Impartial Conduct Standards only be required as a condition of the exemption, and not give rise to contract claims. Other commenters advocated for the opposite result, asserting that the Impartial Conduct Standards should be required for contractual promises only, and not treated as exemption conditions. These commenters asserted that the Impartial Conduct Standards are too vague and would result in uncertainty as to whether an excise tax under the Code, which is self-assessed, is owed. There were also suggestions to limit the contractual representation to the Best Interest standard alone. One commenter asserted that the favorable price requirement and the obligation not to make misleading statements fall within a Best Interest standard, and do not need to be stated separately. There were also suggestions that the Impartial Conduct Standards not apply to ERISA plans because fiduciaries to these plans already are required to adhere to similar statutory fiduciary obligations. In these commenters’ views, requiring these standards in an exemption is redundant and inappropriately increases the consequences of any fiduciary breach by imposing an excise tax. In response to comments, the Department has revised the language of the Impartial Conduct Standards and provided interpretive guidance to alleviate the commenters’ concerns about uncertainty and litigation risk. However, the Department has concluded that, failure to adhere to the Impartial Conduct Standards should be both a violation of the contract (where required) and the exemption. Accordingly, the Department has not eliminated any of the conduct standards or, for IRAs and non-ERISA plans, restricted them just to conditions of the exemption for Retirement Investors investing in IRAs or non-ERISA plans. In the Department’s view, all the Impartial Conduct Standards form the baseline standards that should be applicable to fiduciaries relying on the exemption; therefore, the Department has not accepted comments suggesting that the contract representation be limited to the Best Interest standard. Making all the Impartial Conduct Standards required contractual promises for dealings with IRAs and other nonERISA plans creates the potential for contractual liability, incentivizes Financial Institutions to comply, and gives injured Retirement Investors a remedy if those Financial Institutions do not comply. This enforceability is critical to the safeguards afforded by the exemption. E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21110 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations As previously discussed, the Impartial Conduct Standards will not unduly increase litigation risk. The standards are not unduly vague or unknown, but rather track longstanding concepts in law and equity. Also, the Department has simplified execution of the contract, streamlined disclosure, and made certain language changes to address legitimate concerns. Similarly, the Department has not accepted the comment that the Impartial Conduct Standards should apply only to IRAs and non-ERISA plans. One of the Department’s goals is to ensure equal footing for all Retirement Investors. The SEC staff Dodd-Frank Study found that investors were frequently confused by the differing standards of care applicable to broker-dealers and registered investment advisers. The Department hopes to minimize such confusion in the market for retirement advice by holding Advisers and Financial Institutions to similar standards, regardless of whether they are giving the advice to an ERISA plan, IRA, or a non-ERISA plan. Moreover, inclusion of the standards in the exemption’s conditions adds an important additional safeguard for ERISA and IRA investors alike because the party engaging in a prohibited transaction has the burden of showing compliance with an applicable exemption, when violations are alleged.36 In the Department’s view, this burden-shifting is appropriate because of the dangers posed by conflicts of interest, as reflected in the Department’s Regulatory Impact Analysis and because of the difficulties Retirement Investors have in effectively policing such violations.37 One important way for Financial Institutions to ensure that they can meet this burden is by implementing strong anti-conflict policies and procedures, and by refraining from creating incentives to violate the Impartial Conduct Standards. Thus, treating the Impartial Conduct Standards as exemption conditions creates an important incentive for Financial Institutions to carefully monitor and oversee their Advisers’ conduct for adherence with fiduciary norms. Moreover, as noted repeatedly, the language for the Impartial Conduct Standards borrows heavily from ERISA and the law of trusts, providing sufficient clarity to alleviate the commenters’ concerns. Ensuring that fiduciary investment advisers adhere to the Impartial Conduct Standards and 36 See, e.g., Fish v. GreatBanc Trust Company, 749 F.3d 671 (7th Cir. 2014). 37 See Regulatory Impact Analysis. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 that all Retirement Investors have an effective legal mechanism to enforce the standards are central goals of this regulatory project. 5. Sales Incentives and Anti-Conflict Policies and Procedures Under Section II(d)(1)–(3) of the exemption, the Financial Institution is required to adopt certain anti-conflict policies and procedures and to insulate Advisers from incentives to violate the Best Interest standard. In order for relief to be available under the exemption, a Financial Institution that meets the definition set forth in the exemption must provide oversight of Advisers’ recommendations, as described in this section. The Financial Institution must prepare a written document describing the Financial Institution’s policies and procedures, and make copies of the document readily available to Retirement Investors, free of charge, upon request as well as on the Financial Institution’s Web site.38 The written description must accurately describe or summarize key components of the policies and procedures relating to conflict-mitigation and incentive practices in a manner that permits Retirement Investors to make an informed judgment about the stringency of the Financial Institution’s protections against conflicts of interest. The Department opted against requiring disclosure of the full policies and procedures to Retirement Investors to avoid giving them a potentially overwhelming amount of information that could run contrary to its purpose (e.g., by alerting Advisers to the particular surveillance mechanisms employed by Financial Institutions). However, the exemption requires that the full policies and procedures must be made available to the Department upon request. These obligations have several important components. First, the Financial Institution must adopt and comply with written policies and procedures reasonably and prudently designed to ensure that its individual Advisers adhere to the Impartial Conduct Standards set forth in Section II(c). Second, the Financial Institution in formulating its policies and procedures, must specifically identify and document its Material Conflicts of Interest associated with principal transactions and riskless principal transactions; adopt measures reasonably and prudently designed to prevent Material Conflicts of Interest from causing violations of the Impartial Conduct Standards set forth in Section 38 See PO 00000 Section IV(e). Frm 00166 Fmt 4701 Sfmt 4700 II(c); and designate a person or persons, identified by name, title or function, responsible for addressing Material Conflicts of Interest and monitoring Advisers’ adherence to the Impartial Conduct Standards. For purposes of the exemption, a Material Conflict of Interest exists when an Adviser or Financial Institution has a financial interest that a reasonable person would conclude could affect the exercise of its best judgment as a fiduciary in rendering advice to a Retirement Investor. Finally, the Financial Institution’s policies and procedures must require that, neither the Financial Institution nor (to the best of its knowledge) any Affiliate uses or relies on quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause individual Advisers to make recommendations regarding principal transactions and riskless principal transactions that are not in the Best Interest of the Retirement Investor. In this respect, however, the exemption makes clear that that requirement does not prevent the Financial Institution or its Affiliates from providing Advisers with differential compensation (whether in type or amount, and including, but not limited to, commissions) based on investment decisions by Plans, participant or beneficiary accounts, or IRAs, to the extent that the policies and procedures and incentive practices, when viewed as a whole, are reasonably and prudently designed to avoid a misalignment of the interests of Advisers with the interests of the Retirement Investors they serve as fiduciaries. The anti-conflict policies and procedures will safeguard the interests of Retirement Investors by causing Financial Institutions to consider the conflicts of interest affecting their provision of advice to Retirement Investors regarding principal transactions and riskless principal transactions and to take action to mitigate the impact of such conflicts. In particular, under the final exemption, Financial Institutions must not use compensation and other employment incentives to the extent they are intended to or would reasonably be expected to cause Advisers to make recommendations that are not in the Best Interest of the Retirement Investor. Financial Institutions must also establish a supervisory structure reasonably and prudently designed to ensure the Advisers will adhere to the E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations Impartial Conduct Standards. Mitigating conflicts of interest associated with principal transactions and riskless principal transactions by requiring greater alignment of the interests of the Adviser and Financial Institution, and the Retirement Investor, is necessary for the Department to make the findings under ERISA section 408(a) and Code section 4975(c)(2) that the exemption is in the interests of, and protective of, Retirement Investors. This warranty gives the Financial Institution a powerful incentive to ensure advice is provided in accordance with fiduciary norms, rather than risk litigation, including class litigation and liability. Like the proposal, the exemption does not specify the precise content of the anti-conflict policies and procedures. This flexibility is intended to allow Financial Institutions to develop policies and procedures that are effective for their particular business models, while prudently ensuring compliance with their and their Advisers’ fiduciary obligations and the Impartial Conduct Standards. The policies and procedures requirement, if taken seriously, can also reduce Financial Institutions’ litigation risk by minimizing incentives for Advisers to provide advice that is not in Retirement Investors’ Best Interest. As adopted in the final exemption, the policies and procedures requirement is a condition of the exemption for all Retirement Investors—in ERISA plans, IRAs and non-ERISA plans. Failure to comply could result in liability under ERISA for engaging in a prohibited transaction and the imposition of an excise tax under the Code, payable to the Treasury. Additionally, with respect to Retirement Investors in IRAs and non-ERISA plans, the requirements take the form of a contractual warranty. The Financial Institution must warrant that it has adopted and will comply with the anti-conflict policies and procedures (including the obligation to avoid misaligned incentives). Failure to comply with the warranty could result in contractual liability. Comments on the proposed policies and procedures requirement are discussed below. As stated above, for ease of use, the Department has included in this preamble the same general discussion of comments as in the Best Interest Contract Exemption, to the extent applicable to principal transactions and riskless principal transactions, despite the fact that some comments discussed below were not made directly with respect to this exemption. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 a. Policies and Procedures Requirement Generally Under the policies and procedures requirement, described in greater detail above, Financial Institutions must adopt and comply with anti-conflict policies and procedures. In addition, neither the Financial Institution nor (to the best of its knowledge) any Affiliates may use or rely on quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the Best Interest of the Retirement Investor. Some commenters were extremely supportive of the policies and procedures requirement as proposed. They expressed the view that the policies and procedures requirement, and in particular the restrictions on compensation and other employment incentives, was one of the most critical investor protections in the proposal because it would cause Financial Institutions to make specific and necessary changes to their compensation arrangements that would result in significant protections to Retirement Investors. Some commenters believed that the Department did not go far enough. These commenters indicated that flat compensation arrangements should be required, or at least that the rules applicable to differential compensation should be more specific and stringent. A few commenters also indicated that, in addition to focusing on the Adviser, the Financial Institution’s policies and procedures need to consider the impact of compensation practices on branch managers. A commenter indicated that branch managers have responsibilities under FINRA’s supervisory rules to ensure suitability and possibly approve individual transactions. The commenter asserted that branch managers financially benefit from Advisers’ recommendations and have a variety of methods of influencing Adviser behavior. Many others objected to the policies and procedures warranty and requested that it be eliminated in the final exemption. Some commenters believed that compliance would require drastic changes to current compensation arrangements or could possibly result in the complete prohibition of commissions and other transactionbased compensation. Other commenters suggested that the requirement should be eliminated as it would be unnecessary in light of the exemption’s PO 00000 Frm 00167 Fmt 4701 Sfmt 4700 21111 Best Interest standard, and because it would unnecessarily increase litigation risk to Financial Institutions. Alternatively, there were requests to clarify specific provisions and provide safe harbors in the policies and procedures requirement. In the final exemption, the Department has retained the general approach of the proposal. The Department concurs with commenters who view the policies and procedures requirement as an important safeguard for Retirement Investors and as a necessary condition for the Department to make the findings under ERISA section 408(a) and Code section 4975(c)(2) that the exemption is in the interests of, and protective of, Retirement Investors. This provision will require Financial Institutions to take concrete and specific steps to ensure that its individual Advisers adhere to the Impartial Conduct Standards, and in particular, forego compensation practices and employment incentives (quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives) that are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the Best Interest of the Retirement Investor. Strong policies and procedures reduce the temptation (conscious or unconscious) to violate the Best Interest standard in the first place by ensuring that the Advisers’ incentives are appropriately aligned with the interests of the customers they serve, and by ensuring appropriate monitoring and supervision of individual Advisers’ conduct. While the Department views the Best Interest standard as critical to the protections of the exemption, the policies and procedures requirement is equally critical as a means of supporting Best Interest advice and protecting Retirement Investors from having to enforce the Best Interest standard after the advice has already been rendered and the damage done. The Department has not made the requirements more stringent, as suggested by some commenters, so as to require completely level compensation. The Department designed the exemption to preserve mark-ups and mark-downs and other payments as applicable to the transaction in connection with principal transactions and riskless principal transactions, thereby preserving existing business models. The Department also adopted the suggestion of one commenter that the exemption require the Financial E:\FR\FM\08APR3.SGM 08APR3 21112 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations Institution to designate a specific person to address Material Conflicts of Interest and monitor Advisers’ adherence to the Impartial Conduct Standards.39 In the proposal, the Department had already suggested that Financial Institutions consider this approach; however, the commenter suggested that it should be a specific requirement and indicated that most Financial Institutions already have a designated compliance officer. The Department concurs with the commenter and has included that requirement in the final exemption, based on the view that formalizing the process for identifying and monitoring these issues will result in increased protections to Retirement Investors. b. Specific Language of Policies and Procedures Requirement There were also questions and comments on certain language in the proposed policies and procedures requirement. As proposed, the components of the policies and procedures requirement in Section II(d) read as follows: • The Financial Institution has adopted written policies and procedures reasonably designed to mitigate the impact of Material Conflicts of Interest and to ensure that its individual Advisers adhere to the Impartial Conduct Standards set forth in Section II(c); • In formulating its policies and procedures, the Financial Institution has specifically identified Material Conflicts of Interest and adopted measures to prevent the Material Conflicts of Interest from causing violations of the Impartial Conduct Standards set forth in Section II(c); and • Neither the Financial Institution nor (to the best of its knowledge) any Affiliate uses quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives to the extent they would tend to encourage individual Advisers to make recommendations regarding principal transactions that are not in the Best Interest of the Retirement Investor. mstockstill on DSK4VPTVN1PROD with RULES3 A few commenters asked the Department to explain the difference between the first and second prongs of the policies and procedures requirement, as proposed. In response, the first prong of the requirement was intended to establish a general standard, 39 One important consideration in addressing conflicts of interest is the Financial Institution’s attentiveness to the qualifications and disciplinary history of the persons it employs to provide such advice. See Egan, Mark, Gregor Matvos and Amit Seru, The Market for Financial Adviser Misconduct, at 3 (February 26, 2016) (‘‘Past offenders are five times more likely to engage in misconduct than the average adviser, even compared with other advisers in the same firm at the same point in time. The large presence of repeat offenders suggests that consumers could avoid a substantial amount of misconduct by avoiding advisers with misconduct records.’’). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 while the second (and third) prongs provided specific rules regarding the policies and procedures requirement. This approach was also adopted in the final exemption. In addition, the language of Section II(d)(3) specifically provides that the third prong of the requirement, requiring Financial Institutions to insulate Advisers from incentives to violate the Best Interest standard, is part of the policies and procedures requirement. There were also comments on (i) the definition and use of the term ‘‘Material Conflicts of Interest;’’ (ii) the language requiring the policies and procedures to be ‘‘reasonably designed’’ to mitigate the impact of such conflicts of interest, and (iii) the meaning of incentives that ‘‘tend to encourage’’ individual Advisers to make recommendations that are not in the Best Interest of the Retirement Investor. These comments are discussed below. i. Materiality A number of commenters focused on the definition of Material Conflict of Interest used in the proposal. Under the definition as proposed, a Material Conflict of Interest exists when an Adviser or Financial Institution ‘‘has a financial interest that could affect the exercise of its best judgment as a fiduciary in rendering advice to a Retirement Investor.’’ Some commenters took the position that the proposal did not adequately explain the term ‘‘material’’ or incorporate a materiality standard into the definition. A commenter wrote that the proposed definition was so broad that it would be difficult for Financial Institutions to comply with the various aspects of the exemption related to Material Conflicts of Interest, such as provisions requiring disclosure of Material Conflicts of Interest. Another commenter indicated that the Department should not use the term ‘‘material’’ in defining conflicts of interest. The commenter believed that it could result in a standard that was too subjective from the perspective of the Adviser and Financial Institution, and could undermine the protectiveness of the exemption. After consideration of the comments, the Department adjusted the definition of Material Conflict of Interest. In the final exemption, a Material Conflict of Interest exists when an Adviser or Financial Institution has a ‘‘financial interest that that a reasonable person would conclude could affect the exercise of its best judgment as a fiduciary in rendering advice to a Retirement Investor.’’ This language responds to concerns about the breadth PO 00000 Frm 00168 Fmt 4701 Sfmt 4700 and potential subjectivity of the standard. The Department did not, as some commenters suggested, include the word ‘‘material’’ in the definition of Material Conflict of Interest, to avoid the potential circularity of that approach. ii. Reasonably Designed One commenter asked that the Department more broadly use the modifier ‘‘reasonably designed’’ in describing the standard the policies and procedures must meet so as to avoid a construction that required standards that ensured perfect compliance, a potentially unattainable standard. The Department has accepted the comment and adjusted the language in Sections II(d)(1) and (2) to generally use the phrase ‘‘reasonably and prudently designed.’’ Other commenters asked for guidance on the proposed phrasing ‘‘reasonably designed to mitigate’’ the impact of Material Conflicts of Interest. The Department provides additional guidance in this respect in the preamble of the Best Interest Contract Exemption published elsewhere in this issue of the Federal Register, which gives examples of some possible approaches to policies and procedures. iii. Tend To Encourage A number of commenters asked for clarification or revision of the proposed exemption’s prohibition of incentives that ‘‘tend to encourage’’ violation of the Best Interest standard, generally to require a tight link between the incentives and the Advisers’ recommendations. Commenters argued that the ‘‘tend to encourage’’ language established a standard that could be impossible to meet in the context of differential compensation. Accordingly, they requested that the Department use language such as ‘‘intended to encourage,’’ ‘‘does encourage,’’ ‘‘causes,’’ or similar formulation. In response to these commenters the Department has adjusted the condition’s language as follows: [N]either the Financial Institution nor (to the best of the Financial Institution’s knowledge) any Affiliate uses or relies on quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause individual Advisers to make recommendations regarding Principal Transactions and Riskless Principal Transactions that are not in the Best Interest of the Retirement Investor (emphasis added). This language more accurately captures the Department’s intent, which was to require that procedures reasonably address Advisers’ incentives, E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations not guarantee perfection. The Department disagrees, however, with the suggestion that Financial Institutions should be permitted to tolerate or create incentives that would ‘‘reasonably be expected to cause such violations’’ unless the Retirement Investor can actually prove the Financial Institution’s intent to cause violations of the standard or the Adviser’s improper motivation in making the recommendation. The aim of the policies and procedures requirement is to require the Financial Institution to take prophylactic measures to ensure that Retirement Advisers adhere to the Impartial Conduct Standards, a goal completely at odds with the creation of incentives to violate the Best Interest standard. In exchange for the receipt of compensation that would otherwise be prohibited by ERISA and the Code, the Financial Institution’s responsibility under the exemption is to protect Retirement Investors from conflicts of interest, not to promote or continue to offer incentives to violate the Best Interest standard. Moreover, absent extensive discovery or the ability to prove the motivations of individual Advisers, Retirement Investors would generally be in a poor position to prove such ill intent. However, the final exemption provides that the policies and procedures requirement does not: mstockstill on DSK4VPTVN1PROD with RULES3 [P]revent the Financial Institution or its Affiliates from providing Advisers with differential compensation (whether in type or amount, and including, but not limited to, commissions) based on investment decisions by Plans, participant or beneficiary accounts, or IRAs, to the extent that the policies and procedures and incentive practices, when viewed as a whole, are reasonably and prudently designed to avoid a misalignment of the interests of Advisers with the interests of the Retirement Investors they serve as fiduciaries (emphasis added). This language is designed to make clear that differential compensation is permitted, but only if the Financial Institution’s policies and procedures, as a whole, are reasonably designed to avoid a misalignment of interests between Advisers and Retirement Investors. For further guidance, the preamble to the Best Interest Contract Exemption, published in this same issue of the Federal Register, provides examples of the types of policies and procedures that may satisfy the warranty. c. Contractual Warranty Versus Exemption Condition In the proposal, both the Adviser and Financial Institution had to give a warranty to the Retirement Investor VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 about the adoption and implementation of anti-conflict policies and procedures. A few commenters indicated that the Adviser should not be required to give the warranty, and questioned whether the Adviser would always be in a position to speak to the Financial Institution’s incentive and compensation arrangements. The Department agrees that the Financial Institution has the primary responsibility for design and implementation of the policies and procedures requirement and, accordingly, has limited the warranty requirement to the Financial Institution. Some commenters believed that even if the Department included a policies and procedure requirement in the exemption, it should not require a warranty on implementation and compliance with the requirement. According to some of these commenters the warranty was unnecessary in light of the Best Interest standard, and would unduly contribute to litigation risk. A few commenters also suggested that a Financial Institution’s failure to comply with the contractual warranty could give rise to a cause of action to Retirement Investors who had suffered no injuries from failure to implement or comply with appropriate policies and procedures. A few other commenters expressed concern that the provision of a warranty could result in tort liability, rather than just contractual liability. Other commenters argued that the Department should require Financial Institutions not only to make an enforceable warranty as a condition of the exemption, but also require actual compliance with the warranty as a condition of the exemption. One such commenter argued that it would be difficult for Retirement Investors to prove that policies and procedures were not ‘‘reasonably designed’’ to achieve the required purpose. As noted above, the final exemption adopts the required policies and procedures as a condition of the exemption. The policies and procedures requirement is a critical part of the exemption’s protections. The risk of liability associated with a non-exempt prohibited transaction gives Financial Institutions a strong incentive to design protective policies and procedures in a way that is consistent with the purposes and requirements of this exemption. Of course, the Department does not expect that successful contract claims will be brought by Retirement Investors without a showing of damages. In addition, the final exemption requires the Financial Institution to make a warranty regarding the policies and procedures in contracts with PO 00000 Frm 00169 Fmt 4701 Sfmt 4700 21113 Retirement Investors regarding IRAs and other non-ERISA plans. The warranty, and potential liability associated with that warranty, gives Financial Institutions both the obligation and the incentive to tamp down harmful conflicts of interest and protect Retirement Investors from misaligned incentives that encourage Advisers to violate the Best Interest standard and other fiduciary obligations and ensures that there is a means to redress the failure to do so. While the warranty exposes Financial Institutions and Advisers to litigation risk, these risks are circumscribed by the availability of binding arbitration for individual claims and the legal restrictions that courts generally use to police class actions. The Department does not share a commenter’s view that it would be too difficult for Retirement Investors to prove that the policies and procedures were not ‘‘reasonably designed’’ to achieve the required purpose. The final exemption requires the Financial Institution to disclose Material Conflicts of Interest associated with the principal transactions and riskless principal transactions to Retirement Investors and to describe its policies and procedures for safeguarding against those conflicts of interest. These disclosures should assist Retirement Investors in assessing the care with which Financial Institutions have designed their procedures, even if they are insufficient to fully convey how vigorously the Financial Institution implements the protections. In some cases, a systemic violation, or the possibility of such a violation, may be apparent on the face of the policies. In other cases, normal discovery in litigation may provide the information necessary. Certainly, if a Financial Institution were to provide significant prizes or bonuses for Advisers to push principal transactions and riskless principal transactions that were not in the Best Interest of Retirement Investors, Retirement Investors would often be in a position to pursue the claim. Most important, however, the enforceable obligation to adopt and comply with the policies and procedures as set forth herein, and to make relevant disclosures of the policies and procedures and of Material Conflicts of Interest, should create a powerful incentive for Financial Institutions to carefully police conflicts of interest, reducing the need for litigation in the first place. In response to commenters that expressed concern about the specific use of the term ‘‘warranty,’’ the Department intends the term to have its standard meaning as a ‘‘promise that something in furtherance of the contract E:\FR\FM\08APR3.SGM 08APR3 21114 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 is guaranteed by one of the contracting parties.’’ 40 The Department merely requires that the contract with IRA and non-ERISA plan investors include an express enforceable promise of compliance with the policies and procedures condition. As previously discussed, the potential liability for violation of the warranty is cabined by the availability of non-binding arbitration in individual claims, and the ability to waive claims for punitive damages and rescission to the extent permitted by applicable law. Additionally, although the policies and procedure requirement applies equally to ERISA plans, the final exemption does not require Financial Institutions to make a warranty with respect to ERISA plans, just as it does not require the execution of a contract with respect to ERISA plans. For these plans, a separate warranty is unnecessary because Title I of ERISA already provides an enforcement mechanism for failure to comply with the policies and procedures requirement. Under ERISA section 502(a), plan participants, fiduciaries, and the Secretary of Labor have ready means to enforce any failure to meet the conditions of the exemption, including a failure to comply with the policies and procedure requirement. A Financial Institution’s failure to comply with the exemption’s policies and procedure requirements would result in a nonexempt prohibited transaction under ERISA section 406 and would likely constitute a fiduciary breach under ERISA section 404. As a result, a plan participant or beneficiary, plan fiduciary, and the Secretary would be able to sue under ERISA section 502(a)(2), (3), or (5) to recover any loss in value to the plan (including the loss in value to an individual account), or to obtain disgorgement of any wrongful profits or unjust enrichment. Accordingly, the warranty is unnecessary in the context of ERISA plans. d. Compliance With Laws Proposed Warranty The proposed exemption also contained a requirement that the Adviser and Financial Institution would have had to warrant that they and their Affiliates would comply with all applicable federal and state laws regarding the rendering of the investment advice, the purchase, sale or holding of the Asset and the payment of compensation related to the purchase, sale and holding. While the Department did receive some support for this 40 Black’s Law Dictionary 10th ed. (2014). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 condition in comments, several commenters opposed this warranty proposal as being overly broad, and urged that it be deleted. The commenters argued that the warranty could create contract claims based on a wide variety of state and federal laws, without regard to the limitations imposed on individual actions under those laws. In addition, commenters suggested that many of the violations associated with these laws could be quite minor or unrelated to the Department’s concerns about conflicts of interest. In response to these comments, the Department has eliminated this warranty from the final exemption. 6. Credit Standards and Liquidity Section II(d)(4) provides that the Financial Institution’s written policies and procedures regarding principal transactions and riskless principal transactions must address how the credit risk and liquidity assessments required by Section III(a)(3) of the exemption will be made. This requirement serves as an implementation tool for the exemption condition that a debt security that is purchased by a plan, participant or beneficiary account, or IRA, possess at the time of purchase no greater than moderate credit risk and sufficiently liquidity that it can be sold at or near its carrying value within a reasonably short period of time. As discussed later in this preamble, when addressing the credit and liquidity conditions set forth in Section III(a) of the exemption, many commenters identified perceived compliance difficulties. Of those comments, one comment was applicable to Section II of the exemption. The commenter suggested that the Financial Institution be required to develop policies and procedures to assist Advisers by specifying how these assessments are to be made. This suggestion addressed some concerns expressed by commenters regarding the credit and liquidity conditions, and the Department concurs with the comment. The Department believes that Financial Institutions will be able to comply with the requirement, in part, by developing, if they do not already exist, policies and procedures to ensure that the credit worthiness and liquidity of debt securities are properly evaluated. 7. Contractual Disclosures Section II(e) of the exemption obligates the Financial Institution to make specified contract disclosures to Retirement Investors in order to ensure that they have basic information about PO 00000 Frm 00170 Fmt 4701 Sfmt 4700 the scope of Adviser conflicts and that they appropriately authorize principal transactions and riskless principal transactions. For advice to Retirement Investors in IRAs and non-ERISA plans, the disclosures must be provided prior to or at the same time as the recommended transaction either as part of the contract or in a separate written disclosure provided to the Retirement Investor. For advice to Retirement Investors regarding investments in ERISA plans, the disclosures must be provided prior to or at the same time as the execution of the recommended transaction. The disclosure may be provided in person, electronically, or by mail. In the disclosures, the Financial Institution must clearly and prominently in a single written disclosure: (1) Set forth in writing (i) the circumstances under which the Adviser and Financial Institution may engage in Principal Transactions and Riskless Principal Transactions with the Plan, participant or beneficiary account, or IRA, (ii) a description of the types of compensation that may be received by the Adviser and Financial Institution in connection with Principal Transactions and Riskless Principal Transactions, including any types of compensation that may be received from third parties, and (iii) identify and disclose the Material Conflicts of Interest associated with Principal Transactions and Riskless Principal Transactions; (2) Except for existing contracts, document the Retirement Investor’s affirmative written consent, on a prospective basis, to Principal Transactions and Riskless Principal Transactions between the Adviser or Financial Institution and the Plan, participant or beneficiary account, or IRA; (3) Inform the Retirement Investor (i) that the consent set forth in Section II(e)(2) is terminable at will upon written notice by the Retirement Investor at any time, without penalty to the Plan or IRA, (ii) of the right to obtain, free of charge, copies of the Financial Institution’s written description of its policies and procedures adopted in accordance with Section II(d), as well as information about the Principal Traded Asset, including its purchase or sales price, and other salient attributes, including, as applicable: The credit quality of the issuer; the effective yield; the call provisions; and the duration, provided that if the Retirement Investor’s request is made prior to the transaction, the information must be provided prior to the transaction, and if the request is made after the transaction, the information must be provided within 30 business days after the request, (iii) that model contract disclosures or other model notice of the contractual terms which are reviewed for accuracy no less than quarterly and updated within 30 days as necessary are maintained on the Financial Institution’s Web site, and (iv) that the Financial Institution’s written description of its policies and procedures adopted in E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 accordance with Section II(d) is available free of charge on the Financial Institution’s Web site; and (4) Describe whether or not the Adviser and Financial Institution will monitor the Retirement Investor’s investments that are acquired through a Principal Transaction or Riskless Principal Transaction and alert the Retirement Investor to any recommended change to those investments and, if so, the frequency with which the monitoring will occur and the reasons for which the Retirement Investor will be alerted. By ‘‘clearly and prominently in a single written disclosure,’’ the Department means that the Financial Institution may provide a document prepared for this purpose containing only the required information, or include the information in a specific section of the contract in which the disclosure information is provided, rather than requiring the Retirement Investor to locate the relevant information in several places throughout a larger disclosure or series of disclosures. In addition, Section II(e)(5) of the exemption provides a mechanism for correcting disclosure errors, without losing the exemption. It provides that the Financial Institution will not fail to satisfy Section II(e), or violate a contractual provision based thereon, solely because it, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the required information, or if the Web site is temporarily inaccessible, provided that (i) in the case of an error or omission on the web, the Financial Institution discloses the correct information as soon as practicable, but not later than 7 days after the date on which it discovers or reasonably should have discovered the error or omission, and (ii) in the case of other disclosures, the Financial Institution discloses the correct information as soon as practicable, but not later than 30 days after the date on which it discovers or reasonably should have discovered the error or omission. Section II(e)(5) further provides that to the extent compliance with the contract disclosure requires Advisers and Financial Institutions to obtain information from entities that are not closely affiliated with them, they may rely in good faith on information and assurances from the other entities, as long as they do not know that the materials are incomplete or inaccurate. This good faith reliance applies unless the entity providing the information to the Adviser and Financial Institution is (1) a person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution; or (2) any officer, VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 director, employee, agent, registered representative, relative (as defined in ERISA section 3(15)), member of family (as defined in Code section 4975(e)(6)) of, or partner in, the Adviser or Financial Institution. Several commenters supported the proposed disclosures. Commenters recognized that well-designed disclosure can serve multiple purposes, including facilitating informed investment decisions. However, even if investors do not carefully review the disclosures they receive, commenters perceived a benefit to investors from the greater transparency of public disclosure. For example, Financial Institutions may change practices that run contrary to Retirement Investors’ interests rather than disclose them publicly. One commenter suggested the disclosures should be strengthened and required for all retirement savings products, even beyond the scope of the Regulation and this exemption. As proposed, the provision required disclosure of complete information about all the fees and other payments currently associated with the Retirement Investor’s investments. Commenters objected to this as overly broad, given the exemption’s limitation to principal transactions. The Department accepted this comment, and limited the disclosure to the information about the principal traded asset, including its purchase or sales price and other salient attributes, while still ensuring timely access by the Retirement Investor. By salient attributes, the Department means the credit quality of the issuer, the effective yield, the call provisions, and the duration, among other similar attributes, and the Department recognizes that the salient attributes will differ depending on the principal traded asset. In accepting this comment, the Department did not elect to modify the disclosure requirement further with qualifiers such as ‘‘reasonably’’ or ‘‘in the Financial Institution’s possession.’’ The Department believes that no additional limitation need be placed on the rights of the Retirement Investor to request information because, if a Financial Institution is advising a Retirement Investor to enter into a principal transaction or a riskless principal transaction, it should have all of the salient information available when providing that advice. The Department also made a clarification, requested by a commenter, that the Retirement Investor’s consent must be withdrawn in writing. The Department concurs that this will provide additional certainty to the parties. FINRA’s suggestion that the parties agree on the extent of monitoring of the PO 00000 Frm 00171 Fmt 4701 Sfmt 4700 21115 Retirement Investor’s investments was adopted, in Section II(e)(4). In making this determination, Financial Institutions should carefully consider whether certain investments can be prudently recommended to the individual Retirement Investor, in the first place, without a mechanism in place for the ongoing monitoring of the investment. Finally, a number of commenters requested relief for good faith, inadvertent failure to comply with the exemption. A specific provision applicable to the Section II(e) disclosures is included in Section II(e)(5). 8. Ineligible Provisions Under Section II(f) of the final exemption, relief is not available if a Financial Institution’s contract with Retirement Investors regarding investments in IRAs and non-ERISA plans contains the following: (1) Exculpatory provisions disclaiming or otherwise limiting liability of the Adviser or Financial Institution for a violation of the contract’s terms; (2) Except as provided in paragraph (f)(4), a provision under which the Plan, IRA or Retirement Investor waives or qualifies its right to bring or participate in a class action or other representative action in court in a dispute with the Adviser or Financial Institution, or in an individual or class claim agrees to an amount representing liquidated damages for breach of the contract; provided that the parties may knowingly agree to waive the Retirement Investor’s right to obtain punitive damages or rescission of recommended transactions to the extent such a waiver is permissible under applicable state or federal law; or (3) Agreements to arbitrate or mediate individual claims in venues that are distant or that otherwise unreasonably limit the ability of the Retirement Investors to assert the claims safeguarded by this exemption. Section II(f)(4) provides that, in the event the provision on pre-dispute arbitration agreements for class or representative claims in paragraph (f)(2) is ruled invalid by a court of competent jurisdiction, this provision shall not be a condition of the exemption with respect to contracts subject to the court’s jurisdiction unless and until the court’s decision is reversed, but all other terms of the exemption shall remain in effect. The purpose of Section II(f) is to ensure that Retirement Investors receive the full benefit of the exemption’s protections, by preventing them from being contracted away. If an Adviser makes a recommendation regarding a principal transaction or a riskless principal transaction, for compensation, within the meaning of the Regulation, he or she may not disclaim the duties or liabilities that flow from that E:\FR\FM\08APR3.SGM 08APR3 21116 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations recommendation. For similar reasons, the exemption is not available if the contract includes provisions that purport to waive a Retirement Investor’s right to bring or participate in class actions. However, contract provisions in which Retirement Investors agree to arbitrate any individual disputes are allowed to the extent permitted by applicable state law. Moreover, Section II(f) does not prevent Retirement Investors from voluntarily agreeing to arbitrate class or representative claims after the dispute has arisen. The Department’s approach in this respect is consistent with FINRA’s rules permitting mandatory pre-dispute arbitration for individual claims, but not for class action claims.41 This rule was adopted in 1992, in response to a directive, articulated by former SEC Chairman David Ruder, that investors have access to courts in appropriate cases.42 Section 12000 of the FINRA manual establishes a Code of Arbitration Procedure for Customer Disputes which sets forth rules on, inter alia, filing claims, amending pleadings, prehearing conferences, discovery, and sanctions for improper behavior. A number of commenters addressed the proposed approach to arbitration and the other ineligible provisions of Section II(f). A discussion of the comments and the Department’s responses follow. mstockstill on DSK4VPTVN1PROD with RULES3 a. Exculpatory Provisions The Department included Section II(f)(1) in the final exemption without changes from the proposal. Commenters did, however, raise a few questions on the provision. In particular, commenters asked whether the contract could disclaim liability for acts or omissions of third parties, and whether there could be venue selection clauses. In addition, commenters asked whether the contract could require exhaustion of arbitration or mediation before filing in court. 41 FINRA rule 12204(a) provides that class actions may not be arbitrated under the FINRA Code of Arbitration Procedures. FINRA rule 2268(d)(3) provides that no predispute arbitration agreement may limit the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement. The FINRA Board of Governors has ruled that a broker’s predispute arbitration agreement with a customer may not include a waiver of the right to file or participate in a class action in court. Department of Enforcement v. Charles Schwab & Co. (Complaint 2011029760201) (Apr. 24, 2014). 42 NASD Notice 92–65 SEC Approval of Amendments Concerning the Exclusion of ClassAction Matters from Arbitration Proceedings and Requiring that Predispute Arbitration Agreements Include a Notice That Class-Action Matters May Not Be Arbitrated, available at http:// finra.complinet.com/en/display/display_ main.html?rbid=2403&element_id=1660. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Section II(f)(1) does not prevent a Financial Institution’s contract with IRA and non-ERISA plan investors from disclaiming liability for acts or omissions of third parties to the extent permissible under applicable law. In addition, for individual claims, reasonable arbitration and mediation requirements are not prohibited. In response to questions about venue selection, the final exemption includes a new Section II(f)(3), which provides that investors may not be required to arbitrate or mediate their individual claims in venues that are distant or that otherwise unreasonably limit their ability to assert the claims safeguarded by this exemption. The Department has not revised Section II(f) to address every provision that may or may not be included in the contract. While some commenters submitted specific requests regarding specific contract language, and others suggested the Department provide model contracts for Financial Institutions to use, the Department has declined to make these changes in the exemption. The Department notes that Section II(f)(1) prohibits all exculpatory provisions disclaiming or otherwise limiting liability of the Adviser or Financial Institution for a violation of the contract’s terms, and Section II(g)(5) prohibits Financial Institutions and Advisers from purporting to disclaim any responsibility or liability for any responsibility, obligation, or duty under Title I of ERISA to the extent the disclaimer would be prohibited by Section 410 of ERISA. Therefore, in response to comments regarding choice of law provisions, modifying ERISA’s statute of limitations, and imposing obligations on the Retirement Investor, the Financial Institutions must determine whether their specific provisions are exculpatory and would disclaim or limit their liability under ERISA, or that of their Advisers. If so, they are not permitted. The Department will provide additional guidance in response to questions and enforcement proceedings b. Arbitration Section II(f)(2) of the final exemption adopts the approach, as proposed, that individual claims may be the subject of contractual pre-dispute binding arbitration. Class or other representative claims, however, must be allowed to proceed in court. The final exemption also provides that contract provisions may not limit recoveries to an amount representing liquidated damages for breach of the contract. However, the final exemption expressly permits Retirement Investors to knowingly PO 00000 Frm 00172 Fmt 4701 Sfmt 4700 waive their rights to obtain punitive damages or rescission of recommended transactions to the extent such waivers are permitted under applicable law. Commenters were divided on the approach taken in the proposal, as discussed below. Some commenters objected to limiting Retirement Investors’ right to sue in court on individual claims and specifically focused on the FINRA arbitration process. These commenters described FINRA’s process as an unequal playing field, with insufficient protections for individual investors. They asserted that arbitrators are not required to follow federal or state laws, and so would not be required to enforce the terms of the contract. In addition, commenters complained that the decision of an arbitrator generally is not subject to appeal and cannot be overturned by any court. According to these commenters, even when the arbitrators find in favor of the consumer, the consumers often receive significantly smaller recoveries than they deserve. Moreover, some asserted that binding pre-dispute arbitration may be contrary to the legislative intent of ERISA, which provides for ‘‘ready access to federal courts.’’ Some commenters opposed to arbitration indicated that preserving the right to bring or participate in class actions in court would not give Retirement Investors sufficient access to courts. According to these commenters, allowing Financial Institutions to require resolution of individual claims by arbitration would impose additional and unnecessary hurdles on investors seeking to enforce the Best Interest standard. One commenter warned that the Regulation would make it more difficult for Retirement Investors to pursue class actions because the individualized requirements for proving fiduciary status could undermine any claims about commonality. Commenters said that class action lawsuits tend to be expensive and protracted, and even where successful, investors often recover only a small portion of their losses. Other commenters just as forcefully supported pre-dispute binding arbitration agreements. Some asserted that arbitration is generally quicker and less costly than judicial proceedings. They argued that FINRA has welldeveloped protections in place to protect the interests of aggrieved investors. One commenter pointed out that FINRA requires that the arbitration provisions of a contract be highlighted and disclosed to the customer, and that customers be allowed to choose an ‘‘all- E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations public’’ panel of arbitrators.43 FINRA rules also impose larger filing fees on the industry party than on the investor. Commenters also cited evidence that investors are as likely to prevail in arbitration proceedings as they are in court, and even argued that permitting mandatory arbitration for all disputes would be in investors’ best interest. A number of commenters argued that arbitration should be available for all disputes that may arise under the exemption, including class or representative claims. Some of these commenters favored arbitration of class claims due to concerns about costs and potentially greater liability associated with class actions brought in court. Some commenters took the position that the ability of the Retirement Investor to participate in class actions could deter Financial Institutions from relying on the exemption at all. After consideration of the comments on this subject, the Department has decided to adopt the general approach taken in the proposal. Accordingly, contracts with Retirement Investors may require pre-dispute binding arbitration of individual disputes with the Adviser or Financial Institution. The contract, however, must preserve the Retirement Investor’s right to bring or participate in a class action or other representative action in court in such a dispute in order for the exemption to apply. The Department recognizes that, for many claims, arbitration can be more cost-effective than litigation in court. Moreover, the exemption’s requirement that Financial Institutions acknowledge their own and their Advisers’ fiduciary status should eliminate an issue that frequently arises in disputes over investment advice. In addition, permitting individual matters to be resolved through arbitration tempers the litigation risk and expense for Financial Institutions, without sacrificing Retirement Investors’ ability to secure judicial relief for systemic violations that affect numerous investors through class actions. On the other hand, the option to pursue class actions in court is an important enforcement mechanism for Retirement Investors. Class actions address systemic violations affecting many different investors. Often the monetary effect on a particular investor is too small to justify the pursuit of an individual claim, even in arbitration. Exposure to class claims creates a 43 The term ‘‘Public Arbitrator’’ is defined in FINRA rule 12100(u). According to FINRA, non‘‘Public Arbitrators’’ are often referred to as ‘‘industry’’ arbitrators. See Final Report and Recommendations of the FINRA Dispute Resolution Task Force, released December 16, 2015. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 powerful incentive for Financial Institutions to carefully supervise individual Advisers, and ensure adherence to the Impartial Conduct Standards. This incentive is enhanced by the transparent and public nature of class proceedings and judicial opinions, as opposed to arbitration decisions, which are less visible and pose less reputational risk to Financial Institutions or Advisers found to have violated their obligations. The ability to bar investors from bringing or participating in such claims would undermine important investor rights and incentives for Advisers to act in accordance with the Best Interest standard. As one commenter asserted, courts impose significant hurdles for bringing class actions, but where investors can surmount theses hurdles, class actions are particularly well suited for addressing systemic breaches. Although by definition communications to a specific investor generally must have a degree of specificity in order to constitute fiduciary advice, a class of investors should be able to satisfy the requirements of commonality, typicality and numerosity where there is a systemic or wide-spread problem, such as the adoption or implementation of non-compliant policies and procedures applicable to numerous Retirement Investors, the systematic use of prohibited or misaligned financial incentives, or other violations affecting numerous Retirement Investors in a similar way. Moreover, the judicial system ensures that disputes involving numerous retirement investors and systemic issues will be resolved through a well-established framework characterized by impartiality, transparency, and adherence to precedent. The results and reasoning of court decisions serve as a guide for the consistent application of that law in future cases involving other Retirement Investors and Financial Institutions. This is consistent with the approach long adopted by FINRA and its predecessor self-regulatory organizations. FINRA Arbitration rule 12204 specifically bars class actions from FINRA’s arbitration process and requires that pre-dispute arbitration agreements between brokers and customers contain a notice that class action matters may not be arbitrated. In addition, it provides that a broker may not enforce any arbitration agreement against a member of certified or putative class action, until the certification is denied, the class action is decertified, the class member is excluded from, or elects not participate in, the class. This rule was adopted by the National Association of Securities Dealers and PO 00000 Frm 00173 Fmt 4701 Sfmt 4700 21117 approved by the SEC in 1992.44 In the release announcing this decision, the SEC stated: [T]he NASD believes, and the Commission agrees, that the judicial system has already developed the procedures to manage class action claims. Entertaining such claims through arbitration at the NASD would be difficult, duplicative and wasteful. . . . The Commission agrees with the NASD’s position that, in all cases, class actions are better handled by the courts and that investors should have access to the courts to resolve class actions efficiently.45 In 2014, the FINRA Board of Governors upheld this rule in reviewing an enforcement action.46 Additional Protections One commenter suggested that if the Department preserved the ability of a Financial Institution to require arbitration of claims, it should consider requiring a series of additional safeguards for arbitration proceedings permitted under the exemption. The commenter suggested that the conditions could state that (i) the arbitrator must be qualified and independent; (ii) the arbitration must be held in the location of the person challenging the action; (iii) the cost of the arbitration must be borne by the Financial Institution; (iv) the Financial Institution’s attorneys’ fees may not be shifted to the Retirement Investor, even if the challenge is unsuccessful; (v) statutory remedies may not be limited or altered by the contract; (vi) access to adequate discovery must be permitted; (vii) there must be a written record and a written decision; (viii) confidentiality requirements and protective orders which would prohibit the use of evidence in subsequent cases must be prohibited. The commenter said that some, but not all, of these procedures are currently required by FINRA. The Department declines to mandate additional procedural safeguards for arbitration beyond those already mandated by other applicable federal and state law or self-regulatory organizations. In the Department’s view, the FINRA arbitration rules, in particular, provide significant safeguards for fair dispute resolution, notwithstanding the concerns raised by some commenters. FINRA’s Code of Arbitration Procedures for Customer Disputes applies when required by written agreement between the FINRA member and the customer, or if the 44 SEC Release No. 34–31371 (Oct. 28, 1992), 1992 WL 324491. 45 Id. 46 FINRA Decision, Department of Enforcement v. Charles Schwab & Co. (Complaint 2011029760201), p.14 (Apr. 24, 2014). E:\FR\FM\08APR3.SGM 08APR3 21118 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 customer requests arbitration. The rules cover any dispute between the member and the customer that arises from the member’s business activities, except for disputes involving insurance business activities of a member that is an insurance company.47 FINRA’s code of procedures also provide detailed instructions for initiating and pursuing an arbitration, including rules for selection of arbitrators (FINRA rule 12400), for discovery of evidence (FINRA rule 12505), and expungement of customer dispute information (FINRA rule 12805), which are designed to allow access by investors and preserve fairness for the parties. In addition, FINRA rule 12213 specifies that FINRA will generally select the hearing location closest to the customer. To the extent that the contracts provide for binding arbitration in individual claims, the Department defers to the judgment of FINRA and other regulatory bodies, such as state insurance regulators, responsible for determining the safeguards applicable to arbitration proceedings. Federal Arbitration Act Some commenters asserted that the Department does not have the authority to include the exemption’s provisions on class action waivers under the Federal Arbitration Act (FAA), which they said protects enforceable arbitration agreements and expresses a federal policy in favor of arbitration over litigation. Without clear statutory authority to restrict arbitration, these commenters said, the Department cannot include the provisions on class action waivers. These comments misconstrue the effect of the FAA on the Department’s authority to grant exemptions from prohibited transactions. The FAA protects the validity and enforceability of arbitration agreements. Section 2 of the FAA states: ‘‘[a] written provision in any . . . contract . . . to settle by arbitration a controversy thereafter arising out of such contract . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.’’ 48 This Act was intended to reverse judicial hostility to arbitration and to put arbitration agreements on an equal footing with other contracts.49 Section II(f)(2) of the exemption is fully consistent with the FAA. The exemption does not purport to render an arbitration provision in a contract 47 FINRA rule 12200. 48 9 U.S.C. 2. 49 See AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 342 (2011). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 between a Financial Institution and a Retirement Investor invalid, revocable, or unenforceable. Nor, contrary to the concerns of one commenter, does Section II(f)(2) prohibit such waivers. Both Institutions and Advisers remain free to invoke and enforce arbitration provisions, including provisions that waive or qualify the right to bring a class action or any representative action in court. Instead, such a contract simply does not meet the conditions for relief from the prohibited transaction provisions of ERISA and the Code. As a result, the Financial Institution and Adviser would remain fully obligated under both ERISA and the Code to refrain from engaging in prohibited transactions. In short, Section II(f)(2) does not affect the validity, revocability, or enforceability of a class-action waiver in favor of individual arbitration. This regulatory scheme is thus a far cry from the State judicially created rules that the Supreme Court has held preempted by the FAA,50 and the National Labor Relations Board’s attempt to prohibit class-action waivers as an ‘‘unfair labor practice.’’ 51 The Department has broad discretion to craft exemptions subject to the Department’s overarching obligation to ensure that the exemptions are administratively feasible, in the interests of plan participants, beneficiaries, and IRA owners, and protective of their interests. In this instance, the Department has concluded that the enforcement rights and protections associated with class action litigation are important to safeguarding the Impartial Conduct Standards and other anti-conflict provisions of the exemption. If a Financial Institution enters into a contract requiring binding arbitration of class claims, the Department would not purport to invalidate the provision, but rather would insist that the Financial Institution fully comply with statutory provisions prohibiting conflicted fiduciary transactions in its dealings with its Retirement Investment customers. The FAA is not to the contrary. It neither limits the Department’s express grant of discretionary authority over exemptions, nor entitles parties that enter into arbitration agreements to a pass from the prohibited transaction rules. While the Department is confident that its approach in the exemption does 50 See American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013); AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011). 51 See D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013). PO 00000 Frm 00174 Fmt 4701 Sfmt 4700 not violate the FAA, it has carefully considered the position taken by several commenters that the Department exceeded the Department’s authority in including provisions in the exemption on class and representative claims, and the possibility that a court might rule that the condition regarding arbitration of class claims in Section II(f)(2) of the exemption is invalid based on the FAA. Accordingly, in an abundance of caution, the Department has specifically provided that Section II(f)(2) can be severable if a court finds it invalid based on the FAA. Specifically, Section II(f)(4) provides that: In the event that the provision on predispute arbitration agreements for class or representative claims in paragraph (f)(2) of this Section is ruled invalid by a court of competent jurisdiction, this provision shall not be a condition of this exemption with respect to contracts subject to the court’s jurisdiction unless and until the court’s decision is reversed, but all other terms of the exemption shall remain in effect. The Department is required to find that the provisions of an exemption are administratively feasible, in the interests of plans and their participants and beneficiaries and IRA owners, and protective of participants and beneficiaries and IRA owners. The Department finds that the exemption with paragraph (f)(2) satisfies these requirements. The Department believes, consistent with the position of the SEC and FINRA, that the courts are generally better equipped to handle class claims than arbitration procedures and that the prohibition on contractual provisions mandating arbitration of such claims helps the Department make the requisite statutory findings for granting an exemption. Nevertheless, the Department has determined that, based on all the exemption’s other conditions, it can still make the necessary findings to grant the exemption even without the condition prohibiting pre-dispute agreements to arbitrate class claims. In particular, if a court were to invalidate the condition, the Department would still find that the exemption is administratively feasible, in the interests of plans and their participants and beneficiaries, and protective of the rights of the participants and beneficiaries. It would be less protective, but still sufficient to grant the exemption. The Department’s adoption of the specific severability provision in Section II(f)(4) of the exemption should not be viewed as evidence of the Department’s intent that no other conditions of this or the other exemptions granted today are severable if a court were to invalidate them. E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations Instead, the Department intends that invalidated provisions of the rule and exemptions may be severed when the remainder of the rule and exemptions can function sensibly without them.52 mstockstill on DSK4VPTVN1PROD with RULES3 c. Remedies Some commenters asked whether the proposal’s prohibition of exculpatory clauses would affect the parties’ ability to limit remedies under the contract, particularly regarding liquidated damages, punitive damages, consequential damages and rescission. In response, the Department has added text to Section II(f)(2) in the final exemption clarifying that the parties, in an individual or class claim, may not agree to an amount representing liquidated damages for breach of the contract. However, the exemption, as finalized, expressly permits the parties to knowingly agree to waive the Retirement Investor’s right to obtain punitive damages or rescission of recommended transactions to the extent such a waiver is permissible under applicable state or federal law. In the Department’s view, it is sufficient to the exemptions’ protective purposes to permit recovery of actual losses. The availability of such a remedy should ensure that plaintiffs can be made whole for any losses caused by misconduct, and provide an important deterrent for future misconduct. Accordingly, the exemption does not permit the contract to include liquidated damages provisions, which could limit Retirement Investors’ ability to obtain make-whole relief. On the other hand, the exemption permits waiver of punitive damages to the extent permissible under governing law. Similarly, rescission can result in a remedy that is disproportionate to the injury. In cases where an advice fiduciary breached its obligations, but there was no injury to the participant, a rescission remedy can effectively make the fiduciary liable for losses caused by market changes, rather than its misconduct. These new provisions in section II(f)(2) only apply to waiver of the contract claims; they do not qualify or limit statutory enforcement rights under ERISA. Those statutory remedies generally provide for make-whole relief and to rescission in appropriate cases, but they do not provide for punitive damages. 52 See Davis County Solid Waste Management v. United States Environmental Protection Agency, 108 F.3d 1454, 1459 (D.C. Cir. 1997) (finding that severability depends on an agency’s intent and whether the provisions can operate independently of one another). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 9. General Conditions Applicable to Each Transaction (Section III) Section III of the exemption sets forth conditions that apply to the terms of each principal transaction or a riskless principal transaction entered into under the exemption. Section III(a) applies only to purchases by a Plan, participant or beneficiary account, or IRA, of principal traded assets that are debt securities, as defined in the exemption. Section III(b) and (c) apply to both purchase and sale transactions, involving all principal traded assets. Many comments were received with respect to the proposed conditions, and the Department has revised the proposed language to address these comments. a. Issuer/Underwriter Restrictions Section III(a)(1) and (2) of the exemption provides that the debt security being bought by the Plan, participant or beneficiary account, or IRA must not have been issued or, at the time of the transaction, underwritten by the Financial Institution or any Affiliate. The Department received comments generally objecting to these conditions as unduly limiting investment opportunities to Retirement Investors. Commenters argued that many debt securities will only be available for purchase by a Retirement Investor on a principal basis as part of the initial issuance or underwriting since the debt securities are not frequently resold in small lots to retail investors on either a principal or an agency basis. The Department is sympathetic to the commenters’ position, but has determined to adopt the language without modification. This reflects the Department’s concerns that additional conflicts of interest are inherent in transactions where the issuer or underwriter of a security (whether debt or equity) is a fiduciary to a plan or IRA. In such instances, the Financial Institution generally has either been retained by a third party to sell securities as part of an underwriting and has made guarantees as to such sales and will likely profit from such sales more than in a traditional principal transaction or is issuing securities on its own behalf for the specific purposes of benefiting itself. Further, since generally the issued or underwritten securities are being issued or underwritten by the Financial Institution for the first time, heightened issues regarding pricing and liquidity result. Since these unique conflicts exist with respect to both issuance and underwriting transactions, they would require conditions unique to issuance and underwriter principal PO 00000 Frm 00175 Fmt 4701 Sfmt 4700 21119 transactions, respectively. This exemption was not designed to address such conflicts. The Department believes that permitting such transactions without applying additional conditions would not be protective of participants and beneficiaries of plans and IRA owners. Parties seeking relief for such transactions are encouraged to seek an individual exemption from the Department. b. Credit Standards and Liquidity Section III(a)(3) of the exemption requires that, using information reasonably available to the Adviser at the time of the transaction, the Adviser must determine that the debt security being purchased by the Plan, participant or beneficiary account, or IRA, possesses no greater than a moderate credit risk and is sufficiently liquid that the debt security could be sold at or near its carrying value within a reasonably short period of time. Debt securities subject to a moderate credit risk should possess at least average credit-worthiness relative to other similar debt issues. Moderate credit risk would denote current low expectations of default risk, with an adequate capacity for payment of principal and interest. This condition is intended to identify investment grade securities, and avoid the circumstance in which an investment advice fiduciary can recommend speculative debt securities and then sell them to the Plan, participant or beneficiary account, or IRA, from its own inventory. The SEC used similar provisions in setting credit standards in its regulations, including its Rule 6a–5 issued under the Investment Company Act.53 Some commenters on this aspect of the proposal generally objected to the condition’s lack of objectivity. Some requested that the Department instead specifically condition the exemption on the security’s being ‘‘investment grade,’’ rather than the proposed credit and liquidity standards. While the Department generally intends the exemption to be limited to securities that a reasonable investor would treat as investment grade securities, Section 939A of the Dodd-Frank Act provides that the Department may not ‘‘reference or rely on’’ credit ratings—including ‘‘investment grade’’—in the exemption’s conditions. Accordingly, Advisers and Financial Institutions wishing to rely on the exemption must make a reasonable determination of creditworthiness, 53 17 CFR 270.6a–5, 77 FR 70117 (November 23, 2012). E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21120 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations without automatic adherence to specified credit ratings. Another commenter suggested that the Department replace the liquidity component of the standard with the provision of two quotes or a requirement that the Financial Institution reasonably believe a principal transaction provides a better price than would be available in the absence of a principal transaction. The Department agrees that it is important that the price of the principal transaction or a riskless principal transaction is reasonable and has conditioned the exemption on the Adviser and Financial Institution’s commitment to seek to obtain the best execution reasonably available under the circumstances with respect to the transaction (and for FINRA members, specifically on satisfaction of FINRA rules 2121 (Fair Prices and Commissions) and 5310 (Best Execution and Interpositioning)). However, the Department determined not to replace the liquidity component with the two quote requirement in light of commenters’ views that the requirement was unlikely to be workable or effective in achieving the Department’s aims. Other commenters focused on the timing associated with the liquidity component of the condition. They expressed concern that the condition may apply throughout the time period in which the security is held by the Retirement Investor. The Department revised the operative text to make clear that the standard must be satisfied based on the information reasonably available to the Adviser at the time of the transaction and not thereafter. Nevertheless, the Department notes that the Adviser’s consideration of whether the recommendation is in the Retirement Investor’s Best Interest may also need to include consideration of information that is reasonably available regarding restrictions or near term expected performance of the debt security, in light of the Retirement Investor’s needs and objectives. The Department additionally eliminated the credit standards with respect to sales from a plan, participant or beneficiary account, or IRA; accordingly, this condition will not stand in the way of a plan or IRA selling a security that no longer meets the credit standards to a Financial Institution in a principal transaction. The purpose of the liquidity condition was to protect Retirement Investors from the dangers associated with a conflicted Adviser saddling them with low-quality securities, not to prevent them from disposing of such securities. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Commenters also argued that although the Department cited the similar credit standards set forth in the SEC’s Rule 6a– 5 issued under the Investment Company Act, the Department’s reliance on SEC language as a template for the credit risk language is not necessarily appropriate because the SEC uses the language for a different purpose unrelated to retail accounts. While in a different context, the SEC’s adoption of similar language supports the Department’s view that Financial Institutions are capable of implementing the standard. For that reason, the SEC language remains relevant. Further, the Department itself has previously proposed the use of the same language in multiple class exemptions without material objections by the financial services industry to the workability of the language.54 Some commenters also indicated that the Department’s use of the term ‘‘fair market value’’ in the proposal, in place of the term ‘‘carrying value,’’ that is used in the SEC standard, was confusing. In response, the Department revised the final exemption to use the term ‘‘carrying value’’ rather than ‘‘fair market value.’’ In addition, the Department adopted the suggestion of a commenter that Financial Institutions be required to establish policies and procedures to determine how credit risk and liquidity assessments will be made and to develop standards for such assessments. This requirement is in Section II(d), discussed above, and is intended to provide a mechanism for Financial Institutions to operationalize this requirement. As revised, the Department believes that the credit standards condition can serve a protective role without being too vague or operationally difficult. In addition to operational concerns, commenters addressed whether credit standards should be part of the exemption at all. Some commenters opposed both the credit and liquidity conditions on the grounds that the Department was substituting the Department’s judgment for the judgment of Retirement Investors. Other commenters, however, supported the Department’s approach as imposing appropriate safeguards against the added risk associated with investment advice fiduciaries recommending principal transactions and riskless principal transactions involving securities that possess substantial credit risk or are thinly traded. The Department has decided to retain the credit standards. First, the exemption addresses only those principal transactions and riskless 54 See, PO 00000 78 FR 37572 (June 21, 2013). Frm 00176 Fmt 4701 Sfmt 4700 principal transactions that are the result of the provision of fiduciary investment advice. To the extent that a Retirement Investor is truly acting on his or her own without the advice of an investment advice fiduciary, the necessary exemptive relief already exists. As discussed above, Part II of PTE 75–1 currently provides relief from ERISA section 406(a) for principal transactions so long as the broker-dealer or bank does not render investment advice with respect to the assets involved in the principal transaction. Second, the most commonly held categories of debt securities will continue to be available to plans and IRAs. Most importantly, with respect to investment advice that is being provided by an investment advice fiduciary, the Department believes that inherent conflicts of interest justify the credit and liquidity conditions. As discussed elsewhere in this preamble, principal transactions in particular raise significant conflicts of interest, and are often associated with substantial pricing, transparency and liquidity issues. These concerns are magnified when a debt security is of lesser quality. Further, beyond the Department’s heightened concerns regarding pricing, transparency and liquidity, Financial Institutions may generate higher levels of compensation with respect to lower quality debt securities, generating additional conflicts that would otherwise be absent from principal transactions and riskless principal transactions. Finally, the Department notes that other prohibited transaction exemptions granted by the Department permitting principal transactions between plans and plan fiduciaries also contain similar credit standards.55 c. Agreement, Arrangement or Understanding Section III(b) provides that a principal transaction or a riskless principal transaction may not be part of an agreement, arrangement, or understanding designed to evade compliance with ERISA or the Code, or to otherwise impact the value of the principal traded asset. Such a condition protects against the Adviser or Financial Institution manipulating the terms of the principal transaction or a riskless principal transaction, either as an isolated transaction or as a part of a 55 See PTE 75–1, Part IV, Exemptions from Prohibitions Respecting Certain Classes of Transactions Involving Employee Benefit Plans and Certain Broker-Dealers, Reporting Dealers and Banks, 40 FR 50845 (Oct. 31, 2006), proposed amendment pending, 78 FR 37572 (Friday, June 21, 2013). E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations series of transactions, to benefit themselves or their Affiliates. Further, this condition would also prohibit an Adviser or Financial Institution from engaging in principal transactions with Retirement Investors for the purpose of ridding inventory of unwanted or poorly performing principal traded assets. The Department did not receive comments on this condition, and it has been adopted as proposed, with the substitution of the term ‘‘principal traded asset’’ for ‘‘debt security.’’ mstockstill on DSK4VPTVN1PROD with RULES3 d. Cash Section III(c) requires that the purchase or sale of the principal traded asset must be for no consideration other than cash. By limiting a purchase or sale to cash consideration, the Department intends that relief will not be provided for a principal transaction or a riskless principal transaction that is executed on an in-kind basis. The limitation to cash reflects the Department’s concern that in-kind transactions create complexity and additional conflicts of interest because of the need to value the in-kind asset involved in the transaction. The Department did not receive comments on this condition, and it was adopted as proposed. e. Proposed Pricing Condition Section III(d) of the proposal addressed the pricing of the principal transaction by proposing that the purchase or sale occur at a price that (1) the Adviser and Financial Institution reasonably believe is at least as favorable to the plan, participant or beneficiary account, or IRA, as the price available in a transaction that is not a principal transaction, and (2) is at least as favorable to the plan, participant or beneficiary account, or IRA, as the contemporaneous price for the security, or a similar security if a price is not available for the same security, offered by two ready and willing counterparties that are not Affiliates of the Adviser or Financial Institution. The proposal further provided that when comparing the prices, the Adviser and Financial Institution could take into account commissions and mark-ups/markdowns. Many commenters raised concerns regarding the practicality of the two quote process outlined in proposed Section III(d)(2). A number of commenters did not believe that the two quote process would be workable. They said that two quotes may not be available on all securities, particularly corporate debt securities. They further expressed uncertainty about the meaning of the ‘‘similar securities’’ that could be substituted. In addition, VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 commenters indicated that the time needed to go through the two quote process could interfere with a Financial Institution’s duty of best execution under FINRA rule 5310, or in any event could slow the execution of a transaction, to the detriment of the Retirement Investor. FINRA suggested the exemption should be conditioned on FINRA rule 5310 instead of the proposed two quote requirement. Further, the Department has come to believe that the quotes themselves may not be reliable measure of fair price because they are solicited as comparisons rather than with the intent to purchase or sell. A Financial Institution might be less than rigorous in its solicitation of the two quotes, perhaps seeking quotes that simply validate the Financial Institution’s opinion of the appropriate price for the principal transaction. In light of such comments and concerns, the Department did not adopt the two quote requirement. However, in order to address the Department’s concern about the price of the transaction, as discussed in more detail above, the exemption requires that Advisers and Financial Institutions engaging in the transactions seek to obtain the best execution reasonably available under the circumstances. For FINRA members, the final exemption provides that they must comply with FINRA rules 2121 and 5310. These rules provide for best execution and fair pricing, and they will ensure that the Financial Institution does not use its relationship with a plan or IRA to benefit financially to the detriment of the plan or IRA. One commenter expressed strong support for the intent behind the pricing conditions to protect Retirement Investors. The commenter expressed concern, however, that Financial Institutions could work around the proposed pricing conditions, resulting in the conditions failing to provide the anticipated protections to Retirement Investors. The commenter suggested that Financial Institutions be required to articulate why the principal transaction is in the Retirement Investor’s Best Interest and provide current market data, available from FINRA’s TRACE system, for example, to back up such articulation. Another commenter also suggested that specific pricing information could be made available on request. The Department believes that the Department’s approach in Section II(c)(2) of the final exemption Impartial Conduct Standards implements the intent of the pricing condition proposed in Section III(d)(1). The Department did PO 00000 Frm 00177 Fmt 4701 Sfmt 4700 21121 not adopt the suggestion to require the provision of current market data based upon its concern that the additional costs would likely outweigh the benefits, particularly for retail investors. Because of the nature of the marketplace for principal traded assets, current market data is often difficult to analyze and apply to an individual transaction involving the same asset. Such difficulties are particularly problematic with respect to less sophisticated Retirement Investors who will not have the analytic tools at their disposal to interpret any market data that could be provided to them. Consequently, disclosure of such data would likely be of limited value to retail investors. To the extent that the information would be useful to more sophisticated Retirement Investors, such Retirement Investors typically have the information and necessary analytic tools already available. 10. Disclosure Requirement (Section IV) a. Pre-Transaction Disclosure Section IV(a) of the exemption requires that, prior to or at the same time as the execution of the transaction, the Adviser or Financial Institution must provide the Retirement Investor, orally or in writing, a disclosure of the capacity in which the Financial Institution may act with respect to the transaction. By ‘‘capacity in which the Financial Institution may act,’’ the Department means that the Financial Institution must notify the Retirement Investor if it may act as principal in the transaction. This requirement is intended to harmonize with the SEC’s Temporary Rule 206(3)–3T, which has a similar pre-transaction requirement. Such a harmonization allows for a streamlined disclosure requirement, which places less burden on the Financial Institutions. In the proposal, Section IV(a) would have required the Adviser or Financial Institution to provide a statement, prior to engaging in the principal transaction, that the purchase or sale would be executed as a principal transaction. A few commenters indicated that they would not always know if the transaction would be executed as a principal transaction prior to the transaction. These commenters suggested that the Department adopt the approach in the SEC’s Temporary Rule 206(3)–3T, which a commenter said, requires that an investment adviser inform the client ‘‘of the capacity in which it may act with respect to such transaction.’’ A commenter said this formulation recognized that the investment adviser may not know at E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21122 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations that time whether the transaction would be executed as a principal transaction. The Department concurs with this comment and has revised the pretransaction disclosure to more closely match the language in the SEC’s Temporary Rule. Some commenters indicated that the Department’s requirement in Section IV(a) was burdensome in that they perceived it to require the Retirement Investor’s affirmative consent to the specific terms of the transaction in advance of the execution. In response, the Department notes that the proposal did not, and the final exemption does not, contemplate such consent. However, the Department notes that the exemption is limited to Advisers and Financial Institutions that act in a nondiscretionary capacity. The proposed pre-transaction disclosure also would have required disclosure of the two quotes received from unrelated counterparties and the mark-up, mark-down or other payment to be applied to the principal transaction.56 Commenters pointed to logistical problems involved in determining a true mark-up/mark-down amount when multiple, unrelated brokers facilitate the principal transaction. They asserted that, in the absence of contextual information, the disclosure of the mark-up/mark-down may not be useful to Retirement Investors. A few commenters suggested that the Department require the disclosure of the maximum and minimum possible mark-up or markdown, with one commenter suggesting that more specific information could be made available upon request. The preamble to the proposed exemption discussed the possibility of defining the mark-up/mark-down by reference to FINRA rule 2121 and the related guidance, and asked for comment on the approach. One commenter, however, said the Department did not provide any methodology for the mark-up/markdown disclosure requirement and, as a result, the Department’s approach would lead to confusion and inconsistent application of the pricing condition. Other commenters suggested that the Department defer to other regulatory and legislative initiatives regarding mark-up/mark-down disclosure—in particular, FINRA’s proposed disclosures in FINRA Regulatory Notice 14–52. The Department was persuaded by the commenters that required disclosure of the mark-up or mark-down might 56 As discussed above, the proposed two quote requirement was not adopted in the final exemption. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 introduce significant complexity to compliance with the exemption, in particular with respect to transactions that could be covered by FINRA’s pending disclosure requirement, and therefore has not adopted the mark-up/ mark-down disclosure requirement in the final exemption. Commenters’ suggestions to require disclosure of the minimum and maximum mark-up/ mark-down were not adopted because the Department believes that this disclosure would not be specific enough to benefit Retirement Investors. b. Confirmation Section IV(b) of the proposal would have required a written confirmation in accordance with Rule 10b–10 under the Exchange Act, that also includes disclosure of the mark-up, mark-down or other payment to be applied to the principal transaction. A number of comments noted that Rule 10b–10 does not currently include disclosure of the mark-up or mark-down, and making the change would be costly. There were also significant comments, discussed elsewhere, as to the practicality of the mark-up or mark-down disclosure, such that the Department determined not to require the disclosure as discussed above. As a result, the requirement to include a mark-up or mark-down as part of the confirmation has been eliminated. Section IV(b) now simply requires the issuance of a confirmation of the transaction. The requirement to provide a confirmation may be met by compliance with the existing Rule 10b– 10, or any successor rule in effect at the time of the transaction, or for Advisers and Financial Institutions not subject to the Exchange Act, similar requirements imposed by another regulator or selfregulatory organization. c. Annual Disclosure Section IV(c) sets forth a requirement under which the Adviser or Financial Institution must provide certain written information clearly and prominently in a single written disclosure to the Retirement Investor on an annual basis. The annual disclosure must include: (1) A list identifying each principal transaction and riskless principal transaction executed in the Retirement Investor’s account in reliance on this exemption during the applicable period and the date and price at which the transaction occurred; and (2) a statement that (i) the consent required pursuant to Section II(e)(2) is terminable at will upon written notice, without penalty to the Plan or IRA, (ii) the right of a Retirement Investor in accordance with Section II(e)(3)(ii) to obtain, free of charge, information about the Principal PO 00000 Frm 00178 Fmt 4701 Sfmt 4700 Traded Asset, including its salient attributes, (iii) model contract disclosures or other model notice of the contractual terms which are reviewed for accuracy no less than quarterly updated within 30 days as necessary are maintained on the Financial Institution’s Web site, and (iv) the Financial Institution’s written description of its policies and procedures adopted in accordance with Section II(d) are available free of charge on the Financial Institution’s Web site. With respect to this requirement, Section IV(d) of the exemption includes a good faith compliance provision, under which the Financial Institution will not fail to satisfy Section IV solely because it, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the required information or if the Web site is temporarily inaccessible, provided that (i) in the case of an error or omission on the web, the Financial Institution discloses the correct information as soon as practicable, but not later than 7 days after the date on which it discovers or reasonably should have discovered the error or omission, and (ii) in the case of other disclosures, the Financial Institution discloses the correct information as soon as practicable, but not later than 30 days after that date on which it discovers or reasonably should have discovered the error or omission. In addition, to the extent compliance with the annual disclosure requires Advisers and Financial Institutions to obtain information from entities that are not closely affiliated with them, the exemption provides that they may rely in good faith on information and assurances from the other entities, as long as they do not know that the materials are incomplete or inaccurate. This good faith reliance applies unless the entity providing the information to the Adviser and Financial Institution is (1) a person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution; or (2) any officer, director, employee, agent, registered representative, relative (as defined in ERISA section 3(15)), member of family (as defined in Code section 4975(e)(6)) of, or partner in, the Adviser or Financial Institution. The proposal included an annual disclosure requirement in Section IV(c) that would have included the following elements: (1) A list identifying each principal transaction engaged in during the applicable period, the prevailing market price at which the Debt Security was purchased or sold, and E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 the applicable mark-up or mark-down or other payment for each Debt Security; and (2) A statement that the consent required pursuant to Section II(e)(2) is terminable at will, without penalty to the Plan or IRA. The disclosure would have been required to be made within 45 days after the end of the applicable year. As finalized, the annual disclosure now includes a list of the principal transactions and riskless principal transactions entered into in reliance on this exemption, and the date and price at which they occurred. As discussed elsewhere in this preamble, the final exemption does not include the disclosure of the mark-up or mark-down in this final exemption. However, the disclosure in the final exemption includes a reminder of the Retirement Investor’s right (in accordance with Section II(e)(3)(ii) of the exemption) to obtain, free of charge, information about the principal traded asset, including its salient attributes. The final exemption also more closely harmonizes with the SEC’s Temporary Rule 206(3)–3T, as requested by some commenters. First, the Department removed the proposed condition that the annual disclosure be provided within 45 days after the end of the applicable year, in favor of the language used in the Temporary Rule that the disclosure be provided ‘‘no less frequently than annually.’’ Second, the Department added the requirement that the annual disclosure provide the date on which the transaction occurred, and a clarification that the disclosure is only required with respect to principal transactions and riskless principal transactions entered into pursuant to this exemption. These elements also harmonize with the SEC’s Temporary Rule. As with the pre-transaction disclosure, the harmonization of the annual disclosure should ease compliance for Financial Institutions. The Department adopted the annual disclosure, despite comments indicating it was unnecessary and duplicative of other disclosures. The annual disclosure provides a summary of the principal transactions and riskless principal transactions entered into during the reporting period and serves a unique purpose in collecting the information provided in the other disclosures. The annual disclosure provides Retirement Investors with the opportunity to review and evaluate all of the principal transactions and riskless principal transactions that occurred under the terms of the exemption during that period. The information provided may give Retirement Investors perspective that they do not gain from the individual confirmations. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Finally, a few commenters objected to Section IV(d) of the proposal, which would have required disclosure of information about the debt security and its purchase or sale, upon reasonable request of the Retirement Investor. Such right of request was viewed as unbounded. The Department concurs with the commenters and has deleted Section IV(d). The Department believes the provision in Section IV(c)(2), that a notice must be provided of the Retirement Investor’s right to obtain, free of charge, information about the Principal Traded Asset, including its salient attributes, serves the same function. As discussed above, one commenter requested that the information must be reasonably available and in the Financial Institution’s possession. The Department believes that no additional limitation need be placed on the rights of the Retirement Investor to request information because, if a Financial Institution is advising a Retirement Investor to enter into a principal transaction or a riskless principal transaction, it should have all of the salient information available when providing that advice. 11. Recordkeeping (Section V) Under Section V(a) and (b) of the exemption, the Financial Institution must maintain for six years records necessary for the Department and certain other entities, including plan fiduciaries, participants, beneficiaries and IRA owners, to determine whether the conditions of the exemption have been satisfied. Some commenters stated that they were unsure what information would have to be saved for six years. The Department notes that the language requires that records necessary to demonstrate compliance with the exemption’s conditions must be maintained. The final exemption includes changes to the recordkeeping provision made in accordance with comments on other exemption proposals in connection with the Regulation. First, the text was revised to make clear that the records must be ‘‘reasonably accessible for examination,’’ to remove the subjective views of the person requesting to examine or audit the records. The section also clarifies that fiduciaries, employers, employee organizations, participants and their employees and representatives only have access to information concerning their own plans. In addition, Financial Institutions are not required to disclose privileged trade secrets or privileged commercial or financial information to any of the parties other than the Department, as PO 00000 Frm 00179 Fmt 4701 Sfmt 4700 21123 was also true of the proposal. Financial Institutions are also not required to disclose records if such disclosure would be precluded by 12 U.S.C. 484, relating to visitorial powers over national banks and federal savings associations.57 As revised, the exemption requires the records be ‘‘reasonably’’ available, rather than ‘‘unconditionally available.’’ Finally, additional language was added to clarify that any failure to maintain the required records with respect to a given transaction or set of transactions does not affect the relief for other transactions. The recordkeeping provision in the exemption is necessary to demonstrate compliance with the terms of the exemption and therefore should represent prudent business practices in any event. The Department notes that similar language is used in many other exemptions and has been the Department’s standard recordkeeping requirement for exemptions for some time. 12. Definitions (Section VI) Section VI of the exemption provides definitions of the terms used in the exemption. Most of the definitions received no comment, and they are finalized as proposed. Those terms that have been revised or received comment are below. Additional comments on definitions, such as ‘‘Best Interest,’’ ‘‘Principal Transaction’’ and ‘‘Material Conflict of Interest,’’ are discussed above in their respective sections. a. Adviser The exemption contemplates that an individual person, an Adviser, will provide advice to the Retirement Investor. An Adviser must be an investment advice fiduciary of a plan or IRA who is an employee, independent contractor, agent, or registered representative of a Financial Institution, and the Adviser must satisfy the applicable federal and state regulatory and licensing requirements of banking and securities laws with respect to the covered transaction.58 Advisers may be, for example, registered representatives 57 A commenter with respect to the Best Interest Contract Exemption raised concerns that the Department’s right to review a bank’s records under that exemption could conflict with federal banking laws that prohibit agencies other than the Office of the Comptroller of the Currency (OCC) from exercising ‘‘visitorial’’ powers over national banks and federal savings associations. To address the comment, Financial Institutions are not required to disclose records if the disclosure would be precluded by 12 U.S.C. 484. A corresponding change was made in this exemption. 58 See Section VI(a) of the exemption. E:\FR\FM\08APR3.SGM 08APR3 21124 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations of broker-dealers registered under the Exchange Act. One commenter suggested that applicable federal and state regulatory and licensing language, similar to that in the Best Interest Contract Exemption proposal, be added to the definition. The Department agrees with the commenter, and the exemption contains the suggested language. mstockstill on DSK4VPTVN1PROD with RULES3 b. Financial Institutions A Financial Institution is the entity that employs an Adviser or otherwise retains the Adviser as an independent contractor, agent or registered representative and customarily purchases or sells Principal Traded Assets for its own account in the ordinary course of its business.59 Financial Institutions must be investment advisers registered under the Investment Advisers Act of 1940 or state law, banks, or registered broker-dealers. The Department specifically requested comment on whether there are other types of Financial Institutions that should be included in the definition. No comments were received regarding the need for additional entities to be included. The only comments regarding the definition that were received addressed the language in the proposal that would have required that advice by a bank be delivered through the bank’s trust department. Commenters indicated that the language serves no material purpose. As a result, the definition is finalized as proposed with the exception of the removal of the trust requirement. c. Debt Securities and Principal Traded Assets As discussed in detail above with respect to the scope of the exemption, the Department heard from many commenters that wanted to expand the scope of the assets that would be eligible to participate in principal transactions under the exemption. After a review of individual investments, the Department revised the proposal to include asset backed securities, CDs, UITs and additional investments later determined to be added through individual exemptions. Further, with respect to sales by a plan or IRA in a principal transaction or a riskless principal transaction, all securities or other property are provided exemptive relief. The Department operationalized these additions by revising the proposed definition of a debt security to include asset backed securities guaranteed by an agency or a government sponsored enterprise, both within the meaning of 59 See Section VI(e) of the exemption. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 FINRA rule 6710. Further, in order to capture the remaining investments, the new defined term ‘‘principal traded asset’’ was included in Section VI. The definition of a principal traded asset encompasses both the definition of ‘‘debt security’’ and the other investments listed herein. In addition to the comments discussed above, one commenter stated that requiring that a debt security be offered pursuant to a registration statement under the Securities Act of 1933 was difficult to comply with operationally in the secondary market. The commenter argued that the requirement could be eliminated in reliance on the Best Interest standard. The Department does not agree, and the language is finalized as proposed. Requiring that a security be registered is a straightforward mechanism by which the Department can ensure a base level of regulatory compliance and quality. An Adviser or Financial Institution should be able to verify the registration of a particular debt security by using a variety of sources. d. Affiliate Section VI(b) defines ‘‘Affiliate’’ of an Adviser or Financial Institution as: (1) Any person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution. For this purpose, the term ‘‘control’’ means the power to exercise a controlling influence over the management or policies of a person other than an individual; (2) Any officer, director, partner, employee, or relative (as defined in ERISA section 3(15)), of the Adviser or Financial Institution; or (3) Any corporation or partnership of which the Adviser or Financial Institution is an officer, director, or partner of the Adviser or Financial Institution. The Department received a comment requesting that this definition adopt a securities law definition. The commenter expressed the view that use of a separate definition would make compliance more difficult for brokerdealers. The Department did not accept this comment. Instead, the Department made minor adjustments so that the definition is identical to the affiliate definition incorporated in prior exemptions under ERISA and the Code, that are applicable to broker dealers,60 as well as the definition that is used in the Regulation. Therefore, the definition should not be new to the broker-dealer community, and is consistent with other applicable laws. 60 See, e.g., PTE 75–1, Part II, 40 FR 50845 (Oct. 31, 1975), as amended at 71 FR 5883 (Feb. 3, 2006). PO 00000 Frm 00180 Fmt 4701 Sfmt 4700 e. Independent The term Independent is used in Section I(c)(2)(ii), which precludes Financial Institutions and Advisers from relying on the exemption if they are the named fiduciary or plan administrator, as defined in ERISA section 3(16)(A), with respect to an ERISA-covered plan, unless such Financial Institutions or Advisers are selected to provide advice to the plan by a plan fiduciary that is Independent of the Financial Institutions or Advisers. In the proposed exemption, the definition of Independent provided that the person (e.g., the independent fiduciary appointing the Adviser or Financial Institution under Section I(c)(2)(ii)) could not receive any compensation or other consideration for his or her own account from the Adviser, the Financial Institution or an Affiliate. A commenter indicated that as a result, a number of parties providing services to the Financial Institution, and receiving compensation in return, could not satisfy the Independence requirement. The commenter suggested defining entities that receive less than 5% of their gross income from the fiduciary as Independent. In response, the Department revised the definition of Independent so that it provides that the person’s compensation from the Financial Institution may not be in excess of 2% of the person’s annual revenues based on the prior year. This approach is consistent with the Department’s general approach to fiduciary independence. For example, the prohibited transaction exemption procedures provide a presumption of independence for appraisers and fiduciaries if the revenue they receive from a party is not more than 2% of their total annual revenue.61 The Department has revised the definition accordingly.62 C. Good Faith Commenters requested that the exemption continue to apply in the event of a Financial Institution’s or Adviser’s good faith failure to comply with one or more of the conditions. In the commenters’ views, the exemption was sufficiently complex and the implementation timeline sufficiently short to justify such a provision. For example, FINRA suggested that the Department include a provision for continued application of the exemption 61 29 CFR 2570.31(j). same commenter also requested clarification that an IRA owner will not be deemed to fail the Independence requirement simply because he or she is an employee of the Financial Institution. However, the Independence is not applicable to IRA owners. 62 The E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations despite a failure to comply with ‘‘any term, condition or requirement of this exemption . . . if the failure to comply was insignificant and a good faith and reasonable attempt was made to comply with all applicable terms, conditions and requirements.’’ Several commenters specifically supported FINRA’s suggestion. The Department has reviewed the exemption’s requirements with these comments in mind and has included a good faith correction mechanism for the disclosure requirements in the exemption. These provisions take a similar approach to the provisions in the Department’s regulations under ERISA sections 404 and 408(b)(2). In addition, as discussed above, the Department has eliminated a condition requiring compliance with other federal and state laws, which many commenters had argued could expose them to loss of the exemption based on small or technical violations. The Department has also facilitated compliance by streamlining the contracting process (and eliminating the contract requirement for ERISA plans), reducing the disclosure burden, and extending the time for compliance with many of the exemption’s conditions. These and other changes should reduce the need for a self-correction process for excusing violations. The Department declines to permanently adopt a broader unilateral good faith provision for Financial Institutions and their Advisers that could undermine fiduciaries’ incentive to comply with the fundamental standards imposed by the exemption. The exemption’s primary purpose is to combat harmful conflict of interest. If the exemption is too forgiving of abusive conduct, however, it runs the risk of permitting those same conflicts of interest to play a role in the design of policies and procedures, the use and oversight of adviser-incentives, the supervision of Adviser conduct, and the substance of investment recommendations. At the very least, it could encourage Financial Institutions and Advisers to resolve doubts on such questions in favor of their own financial interests rather than the interests of the Retirement Investor. Given the dangers posed by conflicts, the Department has deliberately structured this exemption to provide a strong counter-incentive to such conduct. Additionally, many of the exemption’s standards, such as the Best Interest standard and the pricing condition, already have a built-in reasonableness or prudence standard governing compliance. It would be inappropriate, in the Department’s view, VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 to create a self-correction mechanism for conduct that was imprudent or unreasonable. For example, the Best Interest standard requires that the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party. Similarly, the policies and procedures requirement under Section II(d) turns to a significant degree on adherence to standards of prudence and reasonableness. Thus, under Section II(d)(1), the Financial Institution is required to adopted and comply with written policies and procedures reasonably and prudently designed to ensure that its individual Advisers adhere to the Impartial Conduct Standards set forth in Section II(c). Additionally, the provision allowing mandatory arbitration of individual claims is also responsive to the practicalities of resolving disputes over small claims. The Department also stresses that violations of the exemption’s conditions with respect to a particular Retirement Investor or transaction, eliminates the availability of the exemption for that investor or transaction. Such violations do not render the exemption unavailable with respect to other Retirement Investors or other transactions. D. Jurisdiction The Department received a number of comments questioning the Department’s jurisdiction and legal authority to proceed with the proposal. A number of commenters focused on the Department’s authority to impose certain conditions as part of this exemption, specifically including the contract requirement and the Impartial Conduct Standards. Some commenters asserted that by requiring a contract for all Retirement Investors, and thereby facilitating contract claims by such parties, the proposal would expand upon the remedies established by Congress under ERISA and the Code. Commenters stated that ERISA preempts state law actions, including breach-ofcontract actions. With respect to IRAs and non-ERISA plans, commenters stated that Congress provided that the enforcement of the prohibited PO 00000 Frm 00181 Fmt 4701 Sfmt 4700 21125 transaction rules should be carried out by the Internal Revenue Service, not private plaintiffs. These commenters argued that the Department’s proposal would impermissibly create a private right of action in violation of Congressional intent. Commenters’ arguments regarding the Impartial Conduct Standards were based generally on the fact that the standards, as noted above, are consistent with longstanding principles of prudence and loyalty set forth in ERISA section 404, but which have no counterpart in the Code. Commenters took the position that because Congress did not choose to impose the standards of prudence and loyalty on fiduciaries with respect to IRAs and non-ERISA plans, the Department exceeded its authority in proposing similar standards as a condition of relief in a prohibited transaction exemption. With respect to ERISA plans, commenters stated that Congress’ separation of the duties of prudence and loyalty (in ERISA section 404) from the prohibited transaction provisions (in ERISA section 406), showed an intent that the two should remain separate. Commenters additionally questioned why the conduct standards were necessary for ERISA plans, when such plans already have an enforceable right to fiduciary conduct that is both prudent and loyal. Commenters asserted that imposing the Impartial Conduct Standards as conditions of the exemption improperly created strict liability for prudence violations. Some commenters additionally took the position that Congress, in the DoddFrank Act, gave the SEC the authority to establish standards for broker-dealers and investment advisers and therefore, the Department did not have the authority to act in that area. The Department disagrees that the exemption exceeds its authority. The Department has clear authority under ERISA section 408(a) and the Reorganization Plan 63 to grant administrative exemptions from the prohibited transaction provisions of both ERISA and the Code. Congress gave the Department broad discretion to grant or deny exemptions and to craft conditions for those exemptions, subject only to the overarching requirement that the exemption be administratively feasible, in the interests of plans, plan participants and beneficiaries and IRA owners, and protective of their rights.64 Nothing in ERISA or the Code suggests 63 See fn. 1, supra, discussing of Reorganization Plan No. 4 of 1978 (5 U.S.C. app. at 214 (2000)). 64 See ERISA section 408(a) and Code section 4975(c)(2). E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21126 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations that, in exercising its express discretion to fashion appropriate conditions, the Department cannot condition exemptions on contractual terms or commitments, or that, in crafting exemptions applicable to fiduciaries, the Department is forbidden to borrow from time-honored trust-law standards and principles developed by the courts to ensure proper fiduciary conduct. In addition, this exemption does not create a cause of action for plan fiduciaries, participants or IRA owners to directly enforce the prohibited transaction provisions of ERISA and the Code in a federal or state-law contract action. Instead, with respect to ERISA plans and participants and beneficiaries, the exemption facilitates the existing statutory enforcement framework by requiring Financial Institutions to acknowledge in writing their fiduciary status and the fiduciary status of their Advisers. With respect to IRAs and nonERISA plans, the exemption requires Advisers and Financial Institutions to make certain enforceable commitments to the advice recipient. Violation of the commitments can result in contractual liability to the Adviser and Financial Institution separate and apart from the legal consequences of a non-exempt prohibited transaction (e.g., an excise tax). There is nothing new about a prohibited transaction exemption requiring certain written documentation between the parties. The Department’s widely-used exemption for Qualified Professional Asset Managers (QPAM), requires that an entity acting as a QPAM acknowledge in a written management agreement that it is a fiduciary with respect to each plan that has retained it.65 Likewise, PTE 2006–16, an exemption applicable to compensation received by fiduciaries in securities lending transactions, requires the compensation to be paid in accordance with the terms of a written instrument.66 Surely, the terms of these documents can be enforced by the parties. In this regard, the statutory authority permits, and in fact requires, that the Department incorporate conditions in administrative exemptions designed to protect the interests of plans, participants and beneficiaries, and IRA owners. The Department has determined that the contract requirement in the final exemption serves a critical protective function. 65 See Section VI(a) of PTE 84–14, 49 FR 9494, March 13, 1984, as amended at 70 FR 49305 (August 23, 2005) and as amended at 75 FR 38837 (July 6, 2010). 66 See Section IV(c) of PTE 2006–16, 71 FR 63786 (Oct. 31, 2006). VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Likewise, the Impartial Conduct Standards represent, in the Department’s view, baseline standards of fundamental fair dealing that must be present when fiduciaries make conflicted investment recommendations to Retirement Investors. After careful consideration, the Department determined that broad relief could be provided to investment advice fiduciaries receiving conflicted compensation only if such fiduciaries provided advice in accordance with the Impartial Conduct Standards—i.e., if they provided prudent advice without regard to the interests of such fiduciaries and their Affiliates and Related Entities, in exchange for reasonable compensation and without misleading investors. These Impartial Conduct Standards are necessary to ensure that Advisers’ recommendations reflect the Best interest of their Retirement Investor customers, rather than the conflicting financial interests of the Advisers and their Financial Institutions. As a result, Advisers and Financial Institutions bear the burden of showing compliance with the exemption and face liability for engaging in a non-exempt prohibited transaction if they fail to provide advice that is prudent or otherwise in violation of the standards. The Department does not view this as a flaw in the exemption, as commenters suggested, but rather as a significant deterrent to violations of important conditions under an exemption that accommodates a wide variety of potentially dangerous compensation practices. The Department similarly disagrees that Congress’ directive to the SEC in the Dodd-Frank Act limits its authority to establish appropriate and protective conditions in the context of a prohibited transaction exemption. Section 913 of the Dodd-Frank Act directs the SEC to conduct a study on the standards of care applicable to brokers-dealers and investment advisers, and issue a report containing, among other things: an analysis of whether [sic] any identified legal or regulatory gaps, shortcomings, or overlap in legal or regulatory standards in the protection of retail customers relating to the standards of care for brokers, dealers, investment advisers, persons associated with brokers or dealers, and persons associated with investment advisers for providing personalized investment advice about securities to retail customers.67 Section 913 of the Dodd-Frank Act authorizes, but does not require, the SEC to issue rules addressing standards of care for broker-dealers and investment advisers for providing personalized investment advice about securities to retail customers.68 Nothing in the Dodd-Frank Act indicates that Congress meant to preclude the Department’s regulation of fiduciary investment advice under ERISA or its application of such a regulation to securities brokers or dealers. To the contrary, the Dodd-Frank Act in directing the SEC study specifically directed the SEC to consider the effectiveness of existing legal and regulatory standard of care under other federal and state authorities.69 The Dodd-Frank Act did not take away the Department’s responsibility with respect to the definition of fiduciary under ERISA and in the Code; nor did it qualify the Department’s authority to issue exemptions that are administratively feasible, in the interests of plans, participants and beneficiaries, and IRA owners, and protective of the rights of participants and beneficiaries of the plans and IRA owners. If the Department were unable to rely on contract conditions and trustlaw principles, it would be unable to grant broad relief under this exemption from the rigid application of the prohibited transaction rules. This enforceable standards-based approach enabled the Department to grant relief to a much broader range of practices and compensation structures than would otherwise have been possible. Additionally, the Department notes that nothing in ERISA or the Code requires any Adviser or Financial Institution to use this exemption. Exemptions, including this class exemption, simply provide a means to engage in a transaction otherwise prohibited by the statutes. The conditions to an exemption are not equivalent to a regulatory mandate that conflicts with or changes the statutory remedial scheme. If Advisers or Financial Institutions do not want to be subject to contract claims, they can (1) change their trading practices and avoid committing a prohibited transaction, (2) use the statutory exemptions in ERISA section 408(b)(14) and section 408(g), or Code section 4975(d)(17) and (f)(8), or (3) apply to the Department for individual exemptions tailored to their particular situations. E. Defer to the Securities and Exchange Commission Many commenters suggested that a uniform standard applicable to all retail accounts would be preferable to the Department’s proposal, and that the Department should work with other 68 15 67 Dodd-Frank PO 00000 Frm 00182 Act, sec. 913(d)(2)(B). Fmt 4701 Sfmt 4700 U.S.C. 80b–11(g)(1). Act, sec. 913(b)(1) and (c)(1). 69 Dodd-Frank E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations regulators, such as the SEC and FINRA, to fashion such an approach. Others suggested that the Department should wait and defer to the SEC’s determination of an appropriate standard for broker-dealers under the Dodd-Frank Act. Still others suggested that the Department should provide exemptions based on fiduciary status under securities laws, or based on compliance with other applicable laws or regulations. FINRA indicated that the proposal should be based on existing principles in federal securities laws and FINRA rules but acknowledged that additional rulemaking would be required. The Department disagrees with the commenters, and believes it is important to move forward with this proposal to remedy the ongoing injury to Retirement Investors as a result of conflicted advice arrangements. ERISA and the Code create special protections applicable to investors in tax qualified plans. The fiduciary duties established under ERISA and the Code are different from those applicable under securities laws, and would continue to differ even if both regimes were interpreted to attach fiduciary status to exactly the same parties and activities. Reflecting the special importance of plan and IRA investments to retirement and health security, this statutory regime flatly prohibits fiduciaries from engaging in transactions involving self-dealing and conflicts of interest unless an exemption applies. Under ERISA and the Code, the Department of Labor has the authority to craft exemptions from these stringent statutory prohibitions, and the Department is specifically charged with ensuring that any exemptions it grants are in the interests of Retirement Investors and protective of these interests. Moreover, the fiduciary provisions of ERISA and the Code broadly protect all investments by Retirement Investors, not just those regulated by the SEC. As a consequence, the Department uniquely has the ability to assure that these fiduciary rules work in harmony for all Retirement Investors, regardless of whether they are investing in securities, insurance products that are not securities, or other types of investments. The Department has taken very seriously its obligation to harmonize the Department’s regulation with other applicable laws, including the securities laws. In pursuing its consultations with other regulators, the Department aimed to coordinate and minimize conflicting or duplicative provisions between ERISA, the Code and federal securities laws. The Department has coordinated—and will continue to VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 coordinate—its efforts with other federal agencies to ensure that the various legal regimes are harmonized to the fullest extent possible. The resulting exemption provides Advisers and Financial Institutions with a choice to provide advice on an unconflicted basis or comply with this exemption or another exemption, which now all require advice to be provided in accordance with basic fiduciary norms. Far from confusing investors, the standards set forth in the exemption ensure that Retirement Investors can uniformly expect to receive advice that is in their best interest with respect to their retirement investments. Moreover, the best interest standard reflects what many investors have believed they were entitled to all along, even though it was not legally required. In this regard, waiting for the SEC to act, as some commenters suggested, would delay the implementation of these important, updated safeguards to plan and IRA investors, and impose substantial costs on them as current harms from conflicted advice would continue. F. Applicability Date and Transition Rules The Regulation will become effective June 7, 2016 and this exemption is issued on this same date. The Regulation is effective at the earliest possible date under the Congressional Review Act. For the exemption, the issuance date serves as the date on which the exemption is intended to take effect for purposes of the Congressional Review Act. This date was selected to provide certainty to plans, plan fiduciaries, plan participants and beneficiaries, IRAs, and IRA owners that the new protections afforded by the final rule are now officially part of the law and regulations governing their investment advice providers, and to inform financial services providers and other affected service providers that the rule and exemption are final and not subject to further amendment or modification without additional public notice and comment. The Department expects that this effective date will remove uncertainty as an obstacle to regulated firms allocating capital and other resources toward transition and longer term compliance adjustments to systems and business practices. The Department has also determined that, in light of the importance of the Regulation’s consumer protections and the significance of the continuing monetary harm to retirement investors without the rule’s changes, an Applicability Date of April 10, 2017, is appropriate for plans and their affected PO 00000 Frm 00183 Fmt 4701 Sfmt 4700 21127 service providers to adjust to the basic change from non-fiduciary to fiduciary status. This exemption has the same Applicability Date; parties may rely on it as of the Applicability Date. Section VII provides a transition period under which relief from the prohibited transaction provisions of ERISA and the Code is available for Financial Institutions and Advisers during the period between the Applicability Date and January 1, 2018 (the ‘‘Transition Period’’). For the Transition Period, full relief under the exemption will be available for Financial Institutions and Advisers subject to more limited conditions than the full set of conditions described above. This period is intended to provide Financial Institutions and Advisers time to prepare for compliance with the conditions of Section II–IV set forth above, while safeguarding the interests of Retirement Investors. The Transition Period conditions set forth in Section VII are subject to the same exclusions in Section I(c), for advice from fiduciaries with discretionary authority over the customer’s investments and specified advice concerning in-house plans. The transitional conditions of Section VII require the Financial Institution and its Advisers to comply with the Impartial Conduct Standards when making recommendations regarding principal transactions and riskless principal transactions to Retirement Investors. The Impartial Conduct Standards required in Section VII are the same as required in Section II(c) but are repeated for ease of use. During the Transition Period, the Financial Institution must additionally provide a written notice to the Retirement Investor prior to or at the same time as the execution of the principal transaction or riskless principal transaction, which may cover multiple transactions or all transactions taking place within the Transition Period, affirmatively stating its and its Adviser(s) fiduciary status under ERISA or the Code or both with respect to the recommendation. The Financial Institution must also state in writing that it and its Advisers will comply with the Impartial Conduct Standards. Further, the Financial Institution’s notice must disclose the circumstances under which the Adviser and Financial Institution may engage in principal transactions and riskless principal transactions with the Plan, participant or beneficiary account or IRA, and its Material Conflicts of Interest. The disclosure may be provided in person, electronically or by mail, and it may be provided in the same document as the E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21128 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations notice required in the transition period for exemption in Section IX of the Best Interest Contract Exemption. Similar to the disclosure provisions of Section II(e), the transitional exemption in Section VII provides for exemptive relief to continue despite errors and omissions in the disclosures, if the Financial Institution acts in good faith and with reasonable diligence. In addition, the Financial Institution must designate a person or persons, identified by name, title or function, responsible for addressing Material Conflicts of Interest and monitoring Advisers’ adherence to the Impartial Conduct Standards. Finally, the Financial Institution must comply with the recordkeeping provision of Section V(a) and (b) of the exemption regarding the transactions entered into during the Transition Period. After the Transition Period, however, the exemption provided in Section VII will no longer be available. After that date, Financial Institutions and Advisers must satisfy all of the applicable conditions described in Sections II–V for the relief in Section I(b) to be available for any prohibited transactions occurring after that date. This includes the requirement to enter into a contract with a Retirement Investor, where required. Financial Institutions relying on the negative consent procedure set forth in Section II(a)(1)(ii) must provide the contractual provisions to Retirement Investors with Existing Contracts prior to January 1, 2018, and allow those Retirement Investors 30 days to terminate the contract. If the Retirement Investor does terminate the contract within that 30day period, this exemption will provide relief for 14 days after the date on which the termination is received by the Financial Institution. The proposed exemption, with the proposed Best Interest Contract Exemption, the proposed Regulation and other exemption proposals, generally set forth an Applicability Date of eight months, although the proposals sought comment on a phase in of conditions. As with other sections of this preamble, the Department is addressing comments regarding the Applicability Date as a cohesive whole. Some commenters, concerned about the ongoing harm to Retirement Investors, urged the Department to implement the Regulation and related exemptions quickly. However, the majority of industry commenters requested a twoto three-year transition period. These commenters requested time to enter into contracts with Retirement Investors (including developing and VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 implementing the policies and procedures and incentive practices that meet the terms of Section II(d)). Some commenters requested the Department allow good faith compliance during the transition period. Others requested the Department phase in the requirements over time. One commenter requested the Best Interest standard become effective immediately, with the other conditions becoming effective within one year. Another comment expressed concern about phasing in the conditions over time, referring to this as a ‘‘piecemeal’’ approach, which would not be helpful to implementing a system to protect Retirement Investors. Other commenters wrote that the Department should repropose the exemption or adopt it as an interim final exemption and seek additional comments. The transition provisions in Section VII of the final exemption respond to commenters’ concerns about ongoing economic harm to Retirement Investors during the period in which Financial Institutions develop systems to comply with the exemption. The provisions require prompt implementation of certain core protections of the exemption in the form of the acknowledgment of fiduciary status, compliance with the Impartial Conduct Standards, and certain important disclosures, to safeguard Retirement Investors’ interests. The provisions recognize, however, that the Financial Institutions will need time to develop policies and procedures and supervisory structures that fully comport with the requirements of the final exemption. Accordingly, during the Transition Period, Financial Institutions are not required to execute the contract or give Retirement Investors warranties or disclosures on their anti-conflict policies and procedures. While the Department expects that Advisers and Financial Institutions will, in fact, adopt prudent supervisory mechanisms to prevent violations of the Impartial Conduct Standards (and potential liability for such violations), the exemption will not require the Financial Institutions to make specific representations on the nature or quality of the policies and procedures during this Transition Period. The Department will be available to respond to Financial Institutions’ request for guidance during this period, as they develop the systems necessary to comply with the exemption’s conditions. The transition provisions also accommodate Financial Institutions’ need for time to prepare for full compliance with the exemption, and therefore full compliance with all the final exemption’s applicable conditions PO 00000 Frm 00184 Fmt 4701 Sfmt 4700 is delayed until January 1, 2018. The Department selected that period, rather than two to three years, as requested by some commenters, in light of the significant adjustments in the final exemption that significantly eased compliance burdens. Although the Department believes that the conditions of the exemption set forth in Section II– V are required to support the Department’s findings required under ERISA section 408(a), and Code section 4975(c)(2) over the long term, the Department recognizes that Financial Institutions may need time to achieve full compliance with these conditions. The Department therefore finds that the provisions set forth in Section VII satisfy the criteria of ERISA section 408(a) and Code section 4975(c)(2) for the transition period because they provide the significant protections to Retirement Investors while providing Financial Institutions with time necessary to achieve full compliance. A similar transition period is provided for the companion Best Interest Contract Exemption due to the corresponding provisions in that exemption that may require time for Financial Institutions to begin compliance. The Department considered, but did not elect, delaying the application of the rule defining fiduciary investment advice until such time as Financial Institutions could make the changes to their practices and compensation structures necessary to comply with Sections II through V of this exemption. The Department believed that delaying the application of the new fiduciary rule would inordinately delay the basic protections of loyalty and prudence that the rule provides. Moreover, a long period of delay could incentivize Financial Institutions to increase efforts to provide conflicted advice to Retirement Investors before it becomes subject to the new rule. The Department understands that many of the concerns regarding the applicability date of the rule are related to the prohibited transaction provisions of ERISA and the Code rather than the basic fiduciary standards. This transition period exemption addresses these concerns by giving Financial Institutions and Advisers necessary time to fully comply with Sections II–V of the exemption. The Department also considered the views of commenters that requested reproposal of the Regulation and exemptions, or issuing the rule and exemptions as interim final rules with requests for additional comment. After reviewing all the comments on the 2015 proposal, which was itself a re-proposal, the Department has concluded that it is in a position to publish a final rule and E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations exemptions. It has carefully considered and responded to the significant issues raised in the comments in drafting the final rule and exemptions. Moreover, the Department has concluded that the difference between the final documents and the proposals are also responsive to the commenters’ concerns and could be reasonably foreseen by affected parties. mstockstill on DSK4VPTVN1PROD with RULES3 No Relief From ERISA Section 406(a)(1)(C) or Code Section 4975(c)(1)(C) for the Provision of Services This exemption will not provide relief from a transaction prohibited by ERISA section 406(a)(1)(C), or from the taxes imposed by Code section 4975(a) and (b) by reason of Code section 4975(c)(1)(C), regarding the furnishing of goods, services or facilities between a plan and a party in interest. The provision of investment advice to a plan under a contract with a fiduciary is a service to the plan and compliance with this exemption will not relieve an Adviser or Financial Institution of the need to comply with ERISA section 408(b)(2), Code section 4975(d)(2), and applicable regulations thereunder. Paperwork Reduction Act Statement In accordance with the requirements of the Paperwork Reduction Act of 1995 (PRA) (44 U.S.C. 3506(c)(2)), the Department solicited comments on the information collections included in the proposed Exemption for Principal Transactions in Certain Debt Securities Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs. 80 FR 21989 (Apr. 20, 2015). The Department also submitted an information collection request (ICR) to OMB in accordance with 44 U.S.C. 3507(d), contemporaneously with the publication of the proposal, for OMB’s review. The Department received two comments from one commenter that specifically addressed the paperwork burden analysis of the information collections. Additionally many comments were submitted, described elsewhere in this preamble and in the preamble to the accompanying final rule, which contained information relevant to the costs and administrative burdens attendant to the proposals. The Department took into account such public comments in connection with making changes to the prohibited transaction exemption, analyzing the economic impact of the proposals, and developing the revised paperwork burden analysis summarized below. In connection with publication of this prohibited transaction exemption, the Department is submitting an ICR to OMB requesting approval of a new VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 collection of information under OMB Control Number 1210–0157. The Department will notify the public when OMB approves the ICR. A copy of the ICR may be obtained by contacting the PRA addressee shown below or at http://www.RegInfo.gov. PRA ADDRESSEE: G. Christopher Cosby, Office of Policy and Research, U.S. Department of Labor, Employee Benefits Security Administration, 200 Constitution Avenue NW., Room N– 5718, Washington, DC 20210. Telephone: (202) 693–8410; Fax: (202) 219–4745. These are not toll-free numbers. As discussed in detail below, the class exemption will permit principal transactions and riskless principal transactions in certain principal traded assets between a plan, participant or beneficiary account, or an IRA, and an Adviser or Financial Institution, and the receipt of a mark-up or mark-down or other payment by the Adviser or Financial Institution for themselves or Affiliates as a result of investment advice. The class exemption will require Financial Institutions to enter into a contractual arrangement with Retirement Investors regarding principal transactions and riskless principal transactions with IRAs and plans not subject to Title I of ERISA (non-ERISA plans), adopt written policies and procedures, make disclosures to Retirement Investors (including with respect to ERISA plans), and on a publicly available Web site, and maintain records necessary to prove that the conditions of the exemption have been met for a period of six (6) years from the date of each principal transaction or riskless principal transaction. In addition, the exemption provides a transition period from the Applicability Date, to January 1, 2018. As a condition of relief during the transition period, Financial Institutions must make a disclosure (transition disclosure) to all Retirement Investors (in ERISA plans, IRAs, and non-ERISA plans) prior to or at the same time as the execution of recommended transactions. These requirements are ICRs subject to the PRA. The Department has made the following assumptions in order to establish a reasonable estimate of the paperwork burden associated with these ICRs: • 51.8 percent of disclosures to Retirement Investors with respect to ERISA plans 70 and 44.1 percent of 70 According to data from the National Telecommunications and Information Agency (NTIA), 33.4 percent of individuals age 25 and over have access to the internet at work. According to PO 00000 Frm 00185 Fmt 4701 Sfmt 4700 21129 contracts with and disclosures to Retirement Investors with respect to IRAs and non-ERISA plans 71 will be distributed electronically via means already used by respondents in the normal course of business and the costs arising from electronic distribution will be negligible, while the remaining contracts and disclosures will be distributed on paper and mailed at a cost of $0.05 per page for materials and $0.49 for first class postage; • Financial Institutions will use existing in-house resources to distribute required contracts and disclosures; • Tasks associated with the ICRs performed by in-house personnel will be performed by clerical personnel at an hourly wage rate of $55.21;72 • Financial Institutions will hire outside service providers to assist with nearly all other compliance costs; • Outsourced legal assistance will be billed at an hourly rate of $335.00;73 • Approximately 6,000 Financial Institutions 74 will utilize the exemption a Greenwald & Associates survey, 84 percent of plan participants find it acceptable to make electronic delivery the default option, which is used as the proxy for the number of participants who will not opt out that are automatically enrolled (for a total of 28.1 percent receiving electronic disclosure at work). Additionally, the NTIA reports that 38.9 percent of individuals age 25 and over have access to the internet outside of work. According to a Pew Research Center survey, 61 percent of internet users use online banking, which is used as the proxy for the number of internet users who will opt in for electronic disclosure (for a total of 23.7 percent receiving electronic disclosure outside of work). Combining the 28.1 percent who receive electronic disclosure at work with the 23.7 percent who receive electronic disclosure outside of work produces a total of 51.8 percent who will receive electronic disclosure overall. 71 According to data from the NTIA, 72.4 percent of individuals age 25 and older have access to the internet. According to a Pew Research Center survey, 61 percent of internet users use online banking, which is used as the proxy for the number of internet users who will opt in for electronic disclosure. Combining these data produces an estimate of 44.1 percent of individuals who will receive electronic disclosures. 72 For a description of the Department’s methodology for calculating wage rates, see http://www.dol.gov/ebsa/pdf/labor-cost-inputsused-in-ebsa-opr-ria-and-pra-burden-calculationsmarch-2016.pdf. The Department’s methodology for calculating the overhead cost input of its wage rates was adjusted from the proposed PTE to the final PTE. In the proposed PTE, the Department based its overhead cost estimates on longstanding internal EBSA calculations for the cost of overhead. In response to a public comment stating that the overhead cost estimates were too low and without any supporting evidence, the Department incorporated published U.S. Census Bureau survey data on overhead costs into its wage rate estimates. 73 This rate is the average of the hourly rate of an attorney with 4–7 years of experience and an attorney with 8–10 years of experience, taken from the Laffey Matrix. See http://www.justice.gov/sites/ default/files/usao-dc/legacy/2014/07/14/ Laffey%20Matrix_2014-2015.pdf 74 One commenter questioned the basis for the Department’s assumption regarding the number of E:\FR\FM\08APR3.SGM Continued 08APR3 21130 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations to engage in principal transactions and riskless principal transactions. mstockstill on DSK4VPTVN1PROD with RULES3 Compliance Costs for Financial Institutions The Department believes that nearly all Financial Institutions will contract with outside service providers to implement the various compliance requirements of this exemption. As described in the regulatory impact analysis, per-Financial Institution costs for broker-dealers (BDs) were calculated by allocating the total cost reductions in the medium assumptions scenario across the Financial Institution size categories, and then subtracting the cost reductions from the per-Financial Institution average costs derived from the Oxford Economics study. The methodology for calculating the perFinancial Institution costs for registered investment advisers (RIAs) is described in detail in the regulatory impact analysis. The Department is attributing 50 percent of the compliance costs for BDs and RIAs to this Exemption and 50 percent of the compliance costs for BDs and RIAs to the Best Interest Contract Exemption, published elsewhere in today’s Federal Register. With the above assumptions, the per-Financial Institution costs are as follows: • Start-Up Costs for Large BDs: $3.7 million • Start-Up Costs for Large RIAs: $3.2 million • Start-Up Costs for Medium BDs: $889,000 • Start-Up Costs for Medium RIAs: $662,000 • Start-Up Costs for Small BDs: $278,000 • Start-Up Costs for Small RIAs: $219,000 • Ongoing Costs for Large BDs: $918,000 • Ongoing Costs for Large RIAs: $803,000 • Ongoing Costs for Medium BDs: $192,000 • Ongoing Costs for Medium RIAs: $143,000 • Ongoing Costs for Small BDs: $60,000 • Ongoing Costs for Small RIAs: $47,000 Financial Institutions likely to use the exemption. According to the ‘‘2015 Investment Management Compliance Testing Survey,’’ Investment Adviser Association, cited in the regulatory impact analysis for the accompanying rule, 63 percent of Registered Investment Advisers service ERISA-covered plans and IRAs. The Department conservatively interprets this to mean that all of the 113 large Registered Investment Advisers (RIAs), 63 percent of the 3,021 medium RIAs (1,903), and 63 percent of the 24,475 small RIAs (15,419) work with ERISA-covered plans and IRAs. The Department assumes that all of the 42 large broker-dealers, and similar shares of the 233 medium broker-dealers (147) and the 3,682 small broker-dealers (2,320) work with ERISAcovered plans and IRAs. According to SEC and FINRA data, cited in the regulatory impact analysis, 18 percent of broker-dealers are also registered as RIAs. Removing these firms from the RIA counts produces counts of 105 large RIAs, 1,877 medium RIAs, and 15,001 small RIAs that work with ERISAcovered plans and IRAs and are not also registered as broker-dealers. Further, according to Hung et al. (2008) (see Regulatory Impact Analysis for complete citation), approximately 13 percent of RIAs report receiving commissions. Additionally, 20 percent of RIAs report receiving performance based fees; however, at least 60 percent of these RIAs are likely to be hedge funds. Thus, as much as 8 percent of RIAs providing investment advice receive performance based fees. Combining the 8 percent of RIAs receiving performance based fees with the 13 percent of RIAs receiving commissions creates a conservative estimate of 21 percent of RIAs that might need exemptive relief. Although the Department believes that very few RIAs that are not also broker-dealers engage in principal transactions and riskless principal transactions, its data to support this belief is limited, so the Department is conservatively assuming that the same RIAs that receive performance-based fees and commissions are the types of RIAs that might engage in principal transactions and riskless principal transactions. In total, the Department estimates that 2,509 brokerdealers and 3,566 RIAs receiving performancebased fees and commissions will use this exemption. As described in detail in the regulatory impact analysis, the Department believes a de minimis number of banks may also use the exemption. In order to engage in transactions and receive compensation covered under this exemption, Section II requires Financial Institutions to acknowledge, in writing, their fiduciary status and adopt written policies and procedures designed to ensure compliance with the Impartial Conduct Standards. Financial Institutions must make certain disclosures to Retirement Investors. Financial institutions must generally enter into a written contract with Retirement Investors with respect to principal transactions and riskless principal transactions with IRAs and non-ERISA plans with certain required provisions, including affirmative agreement to adhere to the Impartial Conduct Standards and, if they are FINRA members, to comply with FINRA rules 2121 and 5310. Section IV requires Financial Institutions and Advisers to make certain disclosures to the Retirement Investor. These disclosures include: (1) A pre-transaction disclosure; (2) a disclosure, on demand, of information regarding the principal traded asset, including its salient attributes; (3) an annual disclosure; (4) transaction confirmations; and (5) a web-based disclosure. Section VII requires Financial Institutions to make a transition disclosure, acknowledging their fiduciary status and that of their Advisers with respect to the Advice, stating the Best Interest standard of care, and describing the circumstances under which principal transactions and VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 PO 00000 Frm 00186 Fmt 4701 Sfmt 4700 riskless principal transactions may occur and the associated Material Conflicts of Interest, prior to engaging in any transactions during the transition period from the Applicability Date to January 1, 2018. The transition disclosure can cover multiple transactions, or all transactions occurring in the transition period. The Department is able to disaggregate an estimate of many of the legal costs from the costs above; however, it is unable to disaggregate any of the other costs. The Department received a comment on the proposed PTE stating that the estimates for legal professional time to draft disclosures were not supported by any empirical evidence. The Department also received multiple comments on the proposed PTE stating that its estimate of 60 hours of legal professional time during the first year a financial institution used the exemption and then no legal professional time in subsequent years was too low. In response to a recommendation made during the Department’s August 2015, public hearing on the proposed rule and exemptions, and in an attempt to create estimates with a clearer empirical evidentiary basis, the Department drafted certain portions of the required disclosures, including a sample contract, the one-time disclosure to the Department, and the transition disclosure. The Department believes that the time spent updating existing contracts and disclosures in future years would be no longer than the time necessary to create the original contracts and disclosures. The Department did not attempt to draft the complete set of required disclosures because it expects that the amount of time necessary to draft such disclosures will vary greatly among firms. For example, the Department did not attempt to draft sample policies and procedures, pretransaction disclosures, disclosures regarding the principal traded assets, or confirmation slips. The Department expects the amount of time necessary to complete these disclosures will vary significantly based on a variety of factors including the nature of a firm’s compensation structure, and the extent to which a firm’s policies and procedures require review and signatures by different individuals. The Department further believes that pretransaction disclosures will be provided orally at de minimis cost, facts and circumstances will vary too widely to accurately depict the disclosures regarding the principal traded assets, and providing confirmation slips is a regular and customary business practice E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations producing de minimis additional burden. Considered in conjunction with the estimates provided in the proposal, the Department estimates that outsourced legal assistance to draft standard contracts, contract disclosures, annual disclosures, and transition disclosures will cost an average of $3,676 per Financial Institution for a total of $22.3 million during the first year. In subsequent years, it will cost an average of $2,978 per Financial Institution for a total of $18.1 million annually to update the contracts, contract disclosures, and annual disclosures. The legal costs of these disclosures were disaggregated from the total compliance costs because these disclosures are expected to be relatively uniform. Although the tested disclosures generally took less time than many of the commenters said they would, the Department acknowledges that the disclosures that were not tested are those that are expected to be the most time consuming. Importantly, as explained in greater detail in section 5.3 of the regulatory impact analysis, the Department is primarily relying on cost data provided by the Securities Industry and Financial Markets Association (SIFMA) and the Financial Services Institute (FSI) to calculate the total cost of the legal disclosures, rather than its own internal drafting of disclosures. Accordingly, in the event that any of the Department’s estimates understate the time necessary to create and update the disclosures, it does not impact the total burden estimates. The total burden estimates were derived from SIFMA and FSI’s all-inclusive costs. Therefore, in the event that legal costs are understated, other cost estimates in this analysis would be overstated in an equal manner. In addition to legal costs for creating the contracts and disclosures, the startup cost estimates include the costs of implementing and updating the IT infrastructure, creating the web disclosures, gathering and maintaining the records necessary to produce the various disclosures, developing policies and procedures, addressing material conflicts of interest, monitoring Advisers’ adherence to the Impartial Conduct Standards, and any other steps necessary to ensure compliance with the conditions of the Exemption not described elsewhere. In addition to legal costs for updating the contracts and disclosures, the ongoing cost estimates include the costs of updating the IT infrastructure, updating the web disclosures, reviewing processes for gathering and maintaining the records necessary to produce the various VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 disclosures, reviewing the policies and procedures, producing the detailed disclosures regarding principal traded assets on request, monitoring investments as agreed upon with the Retirement Investor, addressing material conflicts of interest, monitoring Advisers’ adherence to the Impartial Conduct Standards, and any other steps necessary to ensure compliance with the conditions of the exemption not described elsewhere. These costs total $1.9 billion during the first year and $412.2 million in subsequent years. These costs do not include the costs of producing of distributing disclosures and contracts, which are discussed below. Distribution of Disclosures and Contracts The Department estimates that 14,000 Retirement Investors with respect to ERISA plans and 2.4 million Retirement Investors with respect to IRAs and nonERISA plans will receive a three-page transition disclosure during the first year. Additionally, 14,000 Retirement Investors with respect to ERISA plans will receive a fifteen-page contract disclosure, and 2.4 million Retirement Investors with respect to IRAs and nonERISA plans will receive a fifteen-page contract during the first year. In subsequent years, 4,000 Retirement Investors with respect to ERISA plans will receive a fifteen-page contract disclosure and 490,000 Retirement Investors with respect to IRAs and nonERISA plans will receive a fifteen-page contract. To the extent that Financial Institutions use both the Best Interest Contract Exemption and the Principal Transactions Exemption, these estimates may represent overestimates because significant overlap exists between the requirements of the transition disclosure and the contract for both exemptions. If Financial Institutions choose to use both exemptions with the same clients, they will probably combine the documents. The transition disclosure will be distributed electronically to 51.8 percent of ERISA plan investors and 44.1 percent of IRAs and non-ERISA plan investors during the first year. Paper disclosures will be mailed to the remaining 48.2 percent of ERISA plan investors and 55.9 percent of IRAs and non-ERISA plan investors. The contract disclosure will be distributed electronically to 51.8 percent of the ERISA plan investors during the first year or during any subsequent year in which the plan investor begins a new advisory relationship. Paper contract disclosures will be mailed to 48.2 percent of ERISA plan investors. The contract will be distributed PO 00000 Frm 00187 Fmt 4701 Sfmt 4700 21131 electronically to 44.1 percent of IRAs and non-ERISA plan participants during the first year or during any subsequent year in which the investor begins a new advisory relationship. Paper contracts will be mailed to 55.9 percent of IRAs and non-ERISA plan investors. The Department estimates that electronic distribution will result in de minimis cost, while paper distribution will cost approximately $2.5 million during the first year and $342,000 during subsequent years. Paper distribution will also require two minutes of clerical time to print and mail the disclosure or contract,75 resulting in 85,000 hours at an equivalent cost of $4.7 million during the first year and 9,000 hours at an equivalent cost of $508,000 during subsequent years. The Department estimates that 2.5 million Retirement Investors for ERISA plans, IRAs and non-ERISA plans will receive a two-page annual disclosure during the second year and all subsequent years. The disclosure will be distributed electronically to 51.8 percent of ERISA plan investors and 44.1 percent of IRA holders and nonERISA plan investors. Paper statements will be mailed to 48.2 percent of ERISA plan investors and 55.9 percent of IRA owners and non-ERISA plan participants. The Department estimates that electronic distribution will result in de minimis cost, while paper distribution will cost approximately $812,000.76 Paper distribution will also require two minutes of clerical time to print and mail the statement, resulting in 46,000 hours at an equivalent cost of $2.5 million annually. The Department estimates that Financial Institutions will receive ten requests per year for more detailed principal traded asset information during the second year and all subsequent years. The detailed disclosures will be distributed electronically for 51.8 percent of the ERISA plan investors and 44.1 percent of the IRA holders and non-ERISA plan participants. The Department believes that requests for additional information will be proportionally likely with each Retirement Investor type. Therefore, approximately 34,000 detailed disclosures will be distributed on paper. The Department estimates that electronic distribution will result in de minimis cost, while paper distribution 75 One commenter questioned the basis for this estimate. The Department worked with clerical staff to determine that most notices and disclosures can be printed and prepared for mailing in less than one minute per disclosure. Therefore, an estimate of two minutes per disclosure is a conservative estimate. 76 This cost includes $0.05 per page for materials and $0.49 per mailing for postage. E:\FR\FM\08APR3.SGM 08APR3 21132 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations will cost approximately $25,000. Paper distribution will also require two minutes of clerical time to print and mail the statement, resulting in 1,000 hours at an equivalent cost of $62,000 annually. Overall Summary Overall, the Department estimates that in order to meet the conditions of this Exemption, Financial Institutions and Advisers will distribute approximately 4.9 million disclosures and contracts during the first year and 3.0 million disclosures and contracts during subsequent years. Distributing these disclosures and contracts will result in a total of 85,000 hours of burden during the first year and 56,000 hours of burden in subsequent years. The equivalent cost of this burden is $4.7 million during the first year and $3.1 million in subsequent years. This exemption will result in an outsourced labor, materials, and postage cost burden of $2.0 billion during the first year and $431.5 million during subsequent years. These paperwork burden estimates are summarized as follows: Type of Review: New collection. Agency: Employee Benefits Security Administration, Department of Labor. Titles: (1) Prohibited Transaction Exemption for Principal Transactions in Certain Assets between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs and (2) Final Investment Advice Regulation. OMB Control Number: 1210–0157. Affected Public: Businesses or other for-profits; not for profit institutions. Estimated Number of Respondents: 6,075. Estimated Number of Annual Responses: 4,927,605 during the first year and 3,018,574 during subsequent years. Frequency of Response: When engaging in exempted transaction; Annually. Estimated Total Annual Burden Hours: 85,457 hours during the first year and 56,197 hours in subsequent years. Estimated Total Annual Burden Cost: $1,956,129,694 during the first year and $431,468,619 in subsequent years. mstockstill on DSK4VPTVN1PROD with RULES3 Regulatory Flexibility Act This exemption, which is issued pursuant to ERISA section 408(a) and Code section 4975(c)(2), is part of a broader rulemaking that includes other exemptions and a final regulation published in today’s Federal Register. The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) imposes certain requirements with respect to Federal rules that are subject to the notice and VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 comment requirements of section 553(b) of the Administrative Procedure Act (5 U.S.C. 551 et seq.), or any other laws. Unless the head of an agency certifies that a final rule is not likely to have a significant economic impact on a substantial number of small entities, section 604 of the RFA requires that the agency present a final regulatory flexibility analysis (FRFA) describing the rule’s impact on small entities and explaining how the agency made its decisions with respect to the application of the rule to small entities. The Secretary has determined that this rulemaking, including this exemption, will have a significant economic impact on a substantial number of small entities. The Secretary has separately published a Regulatory Impact Analysis (RIA) which contains the complete economic analysis for this rulemaking including the Department’s FRFA for the rule and the related prohibited transaction exemptions. This section of this preamble sets forth a summary of the FRFA. The RIA is available at www.dol.gov/ebsa. As noted in section 6.1 of the RIA, the Department has determined that regulatory action is needed to mitigate conflicts of interest in connection with investment advice to Retirement Investors. The Regulation is intended to improve plan and IRA investing to the benefit of retirement security. In response to the proposed rulemaking, organizations representing small businesses submitted comments expressing particular concern with three issues: the carve-out for investment education, the Best Interest Contract Exemption, and the carve-out for persons acting in the capacity of counterparties to plan fiduciaries with financial expertise. Section 2 of the RIA contains an extensive discussion of these concerns and the Department’s response. As discussed in section 6.2 of the RIA, the Small Business Administration (SBA) defines a small business in the Financial Investments and Related Activities Sector as a business with up to $38.5 million in annual receipts. In response to a comment received from the SBA’s Office of Advocacy on our Initial Regulatory Flexibility Analysis, the Department contacted the SBA, and received from them a dataset containing data on the number of Financial Institutions by NAICS codes, including the number of Financial Institutions in given revenue categories. This dataset would allow the estimation of the number of Financial Institutions with a given NAICS code that fall below the $38.5 million threshold and therefore be considered small entities by the SBA. PO 00000 Frm 00188 Fmt 4701 Sfmt 4700 However, this dataset alone does not provide a sufficient basis for the Department to estimate the number of small entities affected by the rule. Not all Financial Institutions within a given NAICS code would be affected by this rule, because being an ERISA fiduciary relies on a functional test and is not based on industry status as defined by a NAICS code. Further, not all Financial Institutions within a given NAICS code work with ERISA-covered plans and IRAs. Over 90 percent of broker-dealers, registered investment advisers, insurance companies, agents, and consultants are small businesses according to the SBA size standards (13 CFR 121.201). Applying the ratio of entities that meet the SBA size standards to the number of affected entities, based on the methodology described at greater length in the RIA, the Department estimates that the number of small entities affected by this rule is 2,438 BDs, 16,521 RIAs, 496 Insurers, and 3,358 other ERISA service providers. For purposes of the RFA, the Department continues to consider an employee benefit plan with fewer than 100 participants to be a small entity. Further, while some large employers may have small plans, in general small employers maintain most small plans. The definition of small entity considered appropriate for this purpose differs, however, from a definition of small business that is based on size standards promulgated by the SBA. These small pension plans will benefit from the rule, because as a result of the rule, they will receive non-conflicted advice from their fiduciary service providers. The 2013 Form 5500 filings show nearly 595,000 ERISA covered retirement plans with less than 100 participants. Section 6.5 of the RIA summarizes the projected reporting, recordkeeping, and other compliance costs of the rule and exemptions, which are discussed in detail in section 5 of the RIA. Among other things, the Department concludes that it is likely that some small service providers may find that the increased costs associated with ERISA fiduciary status outweigh the benefits of continuing to service the ERISA plan market or the IRA market. The Department does not believe that this outcome will be widespread or that it will result in a diminution of the amount or quality of advice available to small or other retirement savers, because some Financial Institutions will fill the void and provide services the ERISA plan and IRA market. It is also possible that the economic impact of the E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations rule and exemptions on small entities would not be as significant as it would be for large entities, because anecdotal evidence indicates that small entities do not have as many business arrangements that give rise to conflicts of interest. Therefore, they would not be confronted with the same costs to restructure transactions that would be faced by large entities. Section 5.3.1 of the RIA includes a discussion of the changes to the proposed rule and exemptions that are intended to reduce the costs affecting both small and large business. These include elimination of data collection and annual disclosure requirements in the Best Interest Contract Exemption, and changes to the implementation of the contract requirement in the exemption. Section 7 of the RIA discusses significant regulatory alternatives considered by the Department and the reasons why they were rejected. the employer maintaining the plan and their beneficiaries; (2) The Department finds that the exemption is administratively feasible, in the interests of the plan and of its participants and beneficiaries, and protective of the rights of participants and beneficiaries of the plan; (3) The exemption is applicable to a particular transaction only if the transaction satisfies the conditions specified in the exemption; and (4) The exemption is supplemental to, and not in derogation of, any other provisions of ERISA and the Code, including statutory or administrative exemptions and transitional rules. Furthermore, the fact that a transaction is subject to an administrative or statutory exemption is not dispositive of whether the transaction is in fact a prohibited transaction. Congressional Review Act (a) In general. ERISA and the Internal Revenue Code prohibit fiduciary advisers to employee benefit plans (Plans) and individual retirement plans (IRAs) from self-dealing, including receiving compensation that varies based on their investment recommendations. ERISA and the Code also prohibit fiduciaries from engaging in securities purchases and sales with Plans or IRAs on behalf of their own accounts (Principal Transactions). This exemption permits certain persons who provide investment advice to Retirement Investors (i.e., fiduciaries of Plans, Plan participants or beneficiaries, or IRA owners) to engage in certain Principal Transactions and Riskless Principal Transactions as described below. (b) Exemption. This exemption permits an Adviser or Financial Institution to engage in the purchase or sale of a Principal Traded Asset in a Principal Transaction or Riskless Principal Transaction with a Plan, participant or beneficiary account, or IRA, and receive a mark-up, mark-down or other similar payment as applicable to the transaction for themselves or any Affiliate, as a result of the Adviser’s and Financial Institution’s advice regarding the Principal Transaction or Riskless Principal Transaction. As detailed below, Financial Institutions and Advisers seeking to rely on the exemption must acknowledge fiduciary status, adhere to Impartial Conduct Standards in rendering advice, disclose Material Conflicts of Interest associated with Principal Transactions and Riskless Principal Transactions and obtain the consent of the Plan or IRA. This exemption, along with related exemptions and a final rule published elsewhere in this issue of the Federal Register, is part of a rulemaking that is subject to the Congressional Review Act provisions of the Small Business Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. 801, et seq.) and, will be transmitted to Congress and the Comptroller General for review. This rulemaking, including this exemption is treated as a ‘‘major rule’’ as that term is defined in 5 U.S.C. 804, because it is likely to result in an annual effect on the economy of $100 million or more. mstockstill on DSK4VPTVN1PROD with RULES3 General Information The attention of interested persons is directed to the following: (1) The fact that a transaction is the subject of an exemption under ERISA section 408(a) and Code section 4975(c)(2) does not relieve a fiduciary or other party in interest or disqualified person with respect to a plan or IRA from certain other provisions of ERISA and the Code, including any prohibited transaction provisions to which the exemption does not apply and the general fiduciary responsibility provisions of ERISA section 404 which require, among other things, that a fiduciary act prudently and discharge his or her duties respecting the plan solely in the interests of the participants and beneficiaries of the plan. Additionally, the fact that a transaction is the subject of an exemption does not affect the requirement of Code section 401(a) that the plan must operate for the exclusive benefit of the employees of VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Exemption Section I—Exemption PO 00000 Frm 00189 Fmt 4701 Sfmt 4700 21133 In addition, Financial Institutions must adopt certain policies and procedures, including policies and procedures reasonably designed to ensure that individual Advisers adhere to the Impartial Conduct Standards; and retain certain records. This exemption provides relief from ERISA section 406(a)(1)(A) and (D) and section 406(b)(1) and (2), and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(A), (D), and (E). The Adviser and Financial Institution must comply with the conditions of Sections II–V. (c) Scope of this exemption: This exemption does not apply if: (1) The Adviser: (i) Has or exercises any discretionary authority or discretionary control respecting management of the assets of the Plan, participant or beneficiary account, or IRA involved in the transaction or exercises any discretionary authority or control respecting management or the disposition of the assets; or (ii) has any discretionary authority or discretionary responsibility in the administration of the Plan, participant or beneficiary account, or IRA; or (2) The Plan is covered by Title I of ERISA and (i) the Adviser, Financial Institution or any Affiliate is the employer of employees covered by the Plan, or (ii) the Adviser or Financial Institution is a named fiduciary or plan administrator (as defined in ERISA section 3(16)(A)) with respect to the Plan, or an Affiliate thereof, that was selected to provide investment advice to the plan by a fiduciary who is not Independent. Section II—Contract, Impartial Conduct, and Other Conditions The conditions set forth in this section include certain Impartial Conduct Standards, such as a Best Interest standard, that Advisers and Financial Institutions must satisfy to rely on the exemption. In addition, this section requires Financial Institutions to adopt anti-conflict policies and procedures that are reasonably designed to ensure that Advisers adhere to the Impartial Conduct Standards, and requires disclosure of important information about the Principal Transaction or Riskless Principal Transaction. With respect to IRAs and Plans not covered by Title I of ERISA, the Financial Institutions must agree that they and their Advisers will adhere to the exemption’s standards in a written contract that is enforceable by the Retirement Investors. To minimize compliance burdens, the exemption provides that the contract terms may be incorporated into account opening E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21134 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations documents and similar commonly-used agreements with new customers, and the exemption permits reliance on a negative consent process with respect to existing contract holders. The contract does not need to be executed before the provision of advice to the Retirement Investor to engage in a Principal Transaction or Riskless Principal Transaction. However, the contract must cover any advice given prior to the contract date in order for the exemption to apply to such advice. There is no contract requirement for recommendations to Retirement Investors about investments in Plans covered by Title I of ERISA, but the Impartial Conduct Standards and other requirements of Section II(b)–(e) must be satisfied in order for relief to be available under the exemption, as set forth in Section II(g). Section II(a) imposes the following conditions on Financial Institutions and Advisers: (a) Contracts with Respect to Principal Transactions and Riskless Principal Transactions Involving IRAs and Plans Not Covered by Title I of ERISA. If the investment advice resulting in the Principal Transaction or Riskless Principal Transaction concerns an IRA or a Plan that is not covered by Title I, the advice is subject to an enforceable written contract on the part of the Financial Institution, which may be a master contract covering multiple recommendations, that is entered into in accordance with this Section II(a) and incorporates the terms set forth in Section II(b)–(d). The Financial Institution additionally must provide the disclosures required by Section II(e). The contract must cover advice rendered prior to the execution of the contract in order for the exemption to apply to such advice and related compensation. (1) Contract Execution and Assent. (i) New Contracts. Prior to or at the same time as the execution of the Principal Transaction or Riskless Principal Transaction, the Financial Institution enters into a written contract with the Retirement Investor acting on behalf of the Plan, participant or beneficiary account, or IRA, incorporating the terms required by Section II(b)–(d). The terms of the contract may appear in a standalone document or they may be incorporated into an investment advisory agreement, investment program agreement, account opening agreement, insurance or annuity contract or application, or similar document, or amendment thereto. The contract must be enforceable against the Financial Institution. The Retirement Investor’s VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 assent to the contract may be evidenced by handwritten or electronic signatures. (ii) Amendment of Existing Contracts by Negative Consent. As an alternative to executing a contract in the manner set forth in the preceding paragraph, the Financial Institution may amend Existing Contracts to include the terms required in Section II(b)–(d) by delivering the proposed amendment and the disclosure required by Section II(e) to the Retirement Investor prior to January 1, 2018, and considering the failure to terminate the amended contract within 30 days as assent. An Existing Contract is an investment advisory agreement, investment program agreement, account opening agreement, insurance contract, annuity contract, or similar agreement or contract that was executed before January 1, 2018, and remains in effect. If the Financial Institution elects to use the negative consent procedure, it may deliver the proposed amendment by mail or electronically, provided such means is reasonably calculated to result in the Retirement Investor’s receipt of the proposed amendment, but it may not impose any new contractual obligations, restrictions, or liabilities on the Retirement Investor by negative consent. (2) Notice. The Financial Institution maintains an electronic copy of the Retirement Investor’s contract on the Financial Institution’s Web site that is accessible by the Retirement Investor. (b) Fiduciary. The Financial Institution affirmatively states in writing that the Financial Institution and the Adviser(s) act as fiduciaries under ERISA or the Code, or both, with respect to any investment advice regarding Principal Transactions and Riskless Principal Transactions provided by the Financial Institution or the Adviser subject to the contract, or in the case of an ERISA Plan, with respect to any investment advice regarding Principal Transactions and Riskless Principal Transactions between the Financial Institution and the Plan or participant or beneficiary account. (c) Impartial Conduct Standards. The Financial Institution states that it and its Advisers agree to adhere to the following standards and, they in fact, comply with the standards: (1) When providing investment advice to a Retirement Investor regarding the Principal Transaction or Riskless Principal Transaction, the Financial Institution and Adviser provide investment advice that is, at the time of the recommendation, in the Best Interest of the Retirement Investor. As further defined in Section VI(c), such advice reflects the care, skill, prudence, and PO 00000 Frm 00190 Fmt 4701 Sfmt 4700 diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution, or any Affiliate or other party; (2) The Adviser and Financial Institution seek to obtain the best execution reasonably available under the circumstances with respect to the Principal Transaction or Riskless Principal Transaction. (i) Financial Institutions that are FINRA members shall satisfy this Section II(c)(2) if they comply with the terms of FINRA rules 2121 (Fair Prices and Commissions) and 5310 (Best Execution and Interpositioning), or any successor rules in effect at the time of the transaction, as interpreted by FINRA, with respect to the Principal Transaction or Riskless Principal Transaction. (ii) The Department may identify specific requirements regarding best execution and/or fair prices imposed by another regulator or self-regulatory organization relating to additional Principal Traded Assets pursuant to Section VI(j)(1)(iv) in an individual exemption that may be satisfied as an alternative to the standard set forth in Section II(c)(2) above. (3) Statements by the Financial Institution and its Advisers to the Retirement Investor about the Principal Transaction or Riskless Principal Transaction, fees and compensation related to the Principal Transaction or Riskless Principal Transaction, Material Conflicts of Interest, and any other matters relevant to a Retirement Investor’s decision to engage in the Principal Transaction or Riskless Principal Transaction, will not be materially misleading at the time they are made. (d) Warranty. The Financial Institution affirmatively warrants, and in fact complies with, the following: (1) The Financial Institution has adopted and will comply with written policies and procedures reasonably and prudently designed to ensure that its individual Advisers adhere to the Impartial Conduct Standards set forth in Section II(c); (2) In formulating its policies and procedures, the Financial Institution has specifically identified and documented its Material Conflicts of Interest associated with Principal Transactions and Riskless Principal Transactions; E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations adopted measures reasonably and prudently designed to prevent Material Conflicts of Interest from causing violations of the Impartial Conduct Standards set forth in Section II(c); and designated a person or persons, identified by name, title or function, responsible for addressing Material Conflicts of Interest and monitoring Advisers’ adherence to the Impartial Conduct Standards; (3) The Financial Institution’s policies and procedures require that neither the Financial Institution nor (to the best of the Financial Institution’s knowledge) any Affiliate uses or relies on quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause individual Advisers to make recommendations regarding Principal Transactions and Riskless Principal Transactions that are not in the Best Interest of the Retirement Investor. Notwithstanding the foregoing, the requirement of this Section II(d)(3) does not prevent the Financial Institution or its Affiliates from providing Advisers with differential compensation (whether in type or amount, and including, but not limited to, commissions) based on investment decisions by Plans, participant or beneficiary accounts, or IRAs, to the extent that the policies and procedures and incentive practices, when viewed as a whole, are reasonably and prudently designed to avoid a misalignment of the interests of Advisers with the interests of the Retirement Investors they serve as fiduciaries; (4) The Financial Institution’s written policies and procedures regarding Principal Transactions and Riskless Principal Transactions address how credit risk and liquidity assessments for Debt Securities, as required by Section III(a)(3), will be made. (e) Transaction Disclosures. In the contract, or in a separate single written disclosure provided to the Retirement Investor or Plan prior to or at the same time as the execution of the Principal Transaction or Riskless Principal Transaction, the Financial Institution clearly and prominently: (1) Sets forth in writing (i) the circumstances under which the Adviser and Financial Institution may engage in Principal Transactions and Riskless Principal Transactions with the Plan, participant or beneficiary account, or IRA, (ii) a description of the types of compensation that may be received by the Adviser and Financial Institution in connection with Principal Transactions and Riskless Principal Transactions, VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 including any types of compensation that may be received from third parties, and (iii) identifies and discloses the Material Conflicts of Interest associated with Principal Transactions and Riskless Principal Transactions; (2) Except for Existing Contracts, documents the Retirement Investor’s affirmative written consent, on a prospective basis, to Principal Transactions and Riskless Principal Transactions between the Adviser or Financial Institution and the Plan, participant or beneficiary account, or IRA; (3) Informs the Retirement Investor (i) that the consent set forth in Section II(e)(2) is terminable at will upon written notice by the Retirement Investor at any time, without penalty to the Plan or IRA, (ii) of the right to obtain, free of charge, copies of the Financial Institution’s written description of its policies and procedures adopted in accordance with Section II(d), as well as information about the Principal Traded Asset, including its purchase or sales price, and other salient attributes, including, as applicable: The credit quality of the issuer; the effective yield; the call provisions; and the duration, provided that if the Retirement Investor’s request is made prior to the transaction, the information must be provided prior to the transaction, and if the request is made after the transaction, the information must be provided within 30 business days after the request, (iii) that model contract disclosures or other model notice of the contractual terms which are reviewed for accuracy no less than quarterly and updated within 30 days as necessary are maintained on the Financial Institution’s Web site, and (iv) that the Financial Institution’s written description of its policies and procedures adopted in accordance with Section II(d) is available free of charge on the Financial Institution’s Web site; and (4) Describes whether or not the Adviser and Financial Institution will monitor the Retirement Investor’s investments that are acquired through Principal Transactions and Riskless Principal Transactions and alert the Retirement Investor to any recommended change to those investments and, if so, the frequency with which the monitoring will occur and the reasons for which the Retirement Investor will be alerted. (5) The Financial Institution will not fail to satisfy this Section II(e), or violate a contractual provision based thereon, solely because it, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the PO 00000 Frm 00191 Fmt 4701 Sfmt 4700 21135 required information, or if the Web site is temporarily inaccessible, provided that (i) in the case of an error or omission on the web, the Financial Institution discloses the correct information as soon as practicable, but not later than 7 days after the date on which it discovers or reasonably should have discovered the error or omission, and (ii) in the case of other disclosures, the Financial Institution discloses the correct information as soon as practicable, but not later than 30 days after the date on which it discovers or reasonably should have discovered the error or omission. To the extent compliance with this requires Advisers and Financial Institutions to obtain information from entities that are not closely affiliated with them, they may rely in good faith on information and assurances from the other entities, as long as they do not know that the materials are incomplete or inaccurate. This good faith reliance applies unless the entity providing the information to the Adviser and Financial Institution is (1) a person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution; or (2) any officer, director, employee, agent, registered representative, relative (as defined in ERISA section 3(15)), member of family (as defined in Code section 4975(e)(6)) of, or partner in, the Adviser or Financial Institution. (f) Ineligible Contractual Provisions. Relief is not available under the exemption if a Financial Institution’s contract contains the following: (1) Exculpatory provisions disclaiming or otherwise limiting liability of the Adviser or Financial Institution for a violation of the contract’s terms; (2) Except as provided in paragraph (f)(4) of this section, a provision under which the Plan, IRA or the Retirement Investor waives or qualifies its right to bring or participate in a class action or other representative action in court in a dispute with the Adviser or Financial Institution, or in an individual or class claim agrees to an amount representing liquidated damages for breach of the contract; provided that, the parties may knowingly agree to waive the Retirement Investor’s right to obtain punitive damages or rescission of recommended transactions to the extent such a waiver is permissible under applicable state or federal law; or (3) Agreements to arbitrate or mediate individual claims in venues that are distant or that otherwise unreasonably limit the ability of the Retirement E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21136 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations Investors to assert the claims safeguarded by this exemption. (4) In the event provision on predispute arbitration agreements for class or representative claims in paragraph (f)(2) of this section is ruled invalid by a court of competent jurisdiction, this provision shall not be a condition of this exemption with respect to contracts subject to the court’s jurisdiction unless and until the court’s decision is reversed, but all other terms of the exemption shall remain in effect. (g) ERISA Plans. For recommendations to Retirement Investors regarding Principal Transactions and Riskless Principal Transactions with Plans that are covered by Title I of ERISA, relief under the exemption is conditioned upon the Adviser and Financial Institution complying with certain provisions of Section II, as follows: (1) Prior to or at the same time as the execution of the Principal Transaction or Riskless Principal Transaction, the Financial Institution provides the Retirement Investor with a written statement of the Financial Institution’s and its Advisers’ fiduciary status, in accordance with Section II(b). (2) The Financial Institution and the Adviser comply with the Impartial Conduct Standards of Section II(c). (3) The Financial Institution adopts policies and procedures incorporating the requirements and prohibitions set forth in Section II(d)(1)-(4), and the Financial Institution and Adviser comply with those requirements and prohibitions. (4) The Financial Institution provides the disclosures required by Section II(e). (5) The Financial Institution and Adviser do not in any contract, instrument, or communication purport to disclaim any responsibility or liability for any responsibility, obligation, or duty under Title I of ERISA to the extent the disclaimer would be prohibited by ERISA section 410, waive or qualify the right of the Retirement Investor to bring or participate in a class action or other representative action in court in a dispute with the Adviser or Financial Institution, or require arbitration or mediation of individual claims in locations that are distant or that otherwise unreasonably limit the ability of the Retirement Investors to assert the claims safeguarded by this exemption. Section III—General Conditions The Adviser and Financial Institution must satisfy the following conditions to be covered by this exemption: (a) Debt Security Conditions. Solely with respect to the purchase of a Debt VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 Security by a Plan, participant or beneficiary account, or IRA: (1) The Debt Security being purchased was not issued by the Financial Institution or any Affiliate; (2) The Debt Security being purchased is not purchased by the Plan, participant or beneficiary account, or IRA in an underwriting or underwriting syndicate in which the Financial Institution or any Affiliate is an underwriter or a member; (3) Using information reasonably available to the Adviser at the time of the transaction, the Adviser determines that the Debt Security being purchased: (i) Possesses no greater than a moderate credit risk; and (ii) Is sufficiently liquid that the Debt Security could be sold at or near its carrying value within a reasonably short period of time. (b) Arrangement. The Principal Transaction or Riskless Principal Transaction is not part of an agreement, arrangement, or understanding designed to evade compliance with ERISA or the Code, or to otherwise impact the value of the Principal Traded Asset. (c) Cash. The purchase or sale of the Principal Traded Asset is for cash. Section IV—Disclosure Requirements This section sets forth the Adviser’s and the Financial Institution’s disclosure obligations to the Retirement Investor. (a) Pre-Transaction Disclosure. Prior to or at the same time as the execution of the Principal Transaction or Riskless Principal Transaction, the Adviser or the Financial Institution informs the Retirement Investor, orally or in writing, of the capacity in which the Financial Institution may act with respect to such transaction. (b) Confirmation. The Adviser or the Financial Institution provides a written confirmation of the Principal Transaction or Riskless Principal Transaction. This requirement may be satisfied by compliance with Rule 10b– 10 under the Securities Exchange Act of 1934, or any successor rule in effect in effect at the time of the transaction, or for Advisers and Financial Institutions not subject to the Securities Exchange Act of 1934, similar requirements imposed by another regulator or selfregulatory organization. (c) Annual Disclosure. The Adviser or the Financial Institution sends to the Retirement Investor, no less frequently than annually, written disclosure in a single disclosure: (1) A list identifying each Principal Transaction and Riskless Principal Transaction executed in the Retirement Investor’s account in reliance on this PO 00000 Frm 00192 Fmt 4701 Sfmt 4700 exemption during the applicable period and the date and price at which the transaction occurred; and (2) A statement that (i) the consent required pursuant to Section II(e)(2) is terminable at will upon written notice, without penalty to the Plan or IRA, (ii) the right of a Retirement Investor in accordance with Section II(e)(3)(ii) to obtain, free of charge, information about the Principal Traded Asset, including its salient attributes, (iii) model contract disclosures or other model notice of the contractual terms, which are reviewed for accuracy no less frequently than quarterly and updated within 30 days if necessary, are maintained on the Financial Institution’s Web site, and (iv) the Financial Institution’s written description of its policies and procedures adopted in accordance with Section II(d) are available free of charge on the Financial Institution’s Web site. (d) The Financial Institution will not fail to satisfy this Section IV solely because it, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the required information, or if the Web site is temporarily inaccessible, provided that (i) in the case of an error or omission on the web, the Financial Institution discloses the correct information as soon as practicable, but not later than 7 days after the date on which it discovers or reasonably should have discovered the error or omission, and (ii) in the case of other disclosures, the Financial Institution discloses the correct information as soon as practicable, but not later than 30 days after the date on which it discovers or reasonably should have discovered the error or omission. To the extent compliance with the disclosure requires Advisers and Financial Institutions to obtain information from entities that are not closely affiliated with them, the exemption provides that they may rely in good faith on information and assurances from the other entities, as long as they do not know that the materials are incomplete or inaccurate. This good faith reliance applies unless the entity providing the information to the Adviser and Financial Institution is (1) a person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution; or (2) any officer, director, employee, agent, registered representative, relative (as defined in ERISA section 3(15)), member of family (as defined in Code section 4975(e)(6)) of, or partner in, the Adviser or Financial Institution. (e) The Financial Institution prepares a written description of its policies and E:\FR\FM\08APR3.SGM 08APR3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations mstockstill on DSK4VPTVN1PROD with RULES3 procedures and makes it available on its Web site and additionally, to Retirement Investors, free of charge, upon request. The description must accurately describe or summarize key components of the policies and procedures relating to conflict-mitigation and incentive practices in a manner that permits Retirement Investors to make an informed judgment about the stringency of the Financial Institution’s protections against conflicts of interest. Additionally, Financial Institutions must provide their complete policies and procedures to the Department upon request. Section V—Recordkeeping This section establishes record retention and availability requirements that a Financial Institution must meet in order for it to rely on the exemption. (a) The Financial Institution maintains for a period of six (6) years from the date of each Principal Transaction or Riskless Principal Transaction, in a manner that is reasonably accessible for examination, the records necessary to enable the persons described in Section V(b) to determine whether the conditions of this exemption have been met, except that: (1) If such records are lost or destroyed, due to circumstances beyond the control of the Financial Institution, then no prohibited transaction will be considered to have occurred solely on the basis of the unavailability of those records; and (2) No party other than the Financial Institution that is engaging in the Principal Transaction or Riskless Principal Transaction shall be subject to the civil penalty that may be assessed under ERISA section 502(i) or to the taxes imposed by Code sections 4975(a) and (b) if the records are not maintained or are not available for examination as required by Section V(b). (b)(1) Except as provided in Section V(b)(2) or as precluded by 12 U.S.C. 484, and notwithstanding any provisions of ERISA sections 504(a)(2) and 504(b), the records referred to in Section V(a) are reasonably available at their customary location for examination during normal business hours by: (i) Any duly authorized employee or representative of the Department or the Internal Revenue Service; (ii) any fiduciary of the Plan or IRA that was a party to a Principal Transaction or Riskless Principal Transaction described in this exemption, or any duly authorized employee or representative of such fiduciary; VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 (iii) any employer of participants and beneficiaries and any employee organization whose members are covered by the Plan, or any authorized employee or representative of these entities; and (iv) any participant or beneficiary of the Plan, or the beneficial owner of an IRA. (2) None of the persons described in subparagraph (1)(ii) through (iv) are authorized to examine records regarding a Prohibited Transaction involving another Retirement Investor, or trade secrets of the Financial Institution, or commercial or financial information which is privileged or confidential; and (3) Should the Financial Institution refuse to disclose information on the basis that such information is exempt from disclosure, the Financial Institution must by the close of the thirtieth (30th) day following the request, provide a written notice advising the requestor of the reasons for the refusal and that the Department may request such information. (4) Failure to maintain the required records necessary to determine whether the conditions of this exemption have been met will result in the loss of the exemption only for the transaction or transactions for which records are missing or have not been maintained. It does not affect the relief for other transactions. Section VI—Definitions For purposes of this exemption: (a) ‘‘Adviser’’ means an individual who: (1) Is a fiduciary of a Plan or IRA solely by reason of the provision of investment advice described in ERISA section 3(21)(A)(ii) or Code section 4975(e)(3)(B), or both, and the applicable regulations, with respect to the Assets involved in the transaction; (2) Is an employee, independent contractor, agent, or registered representative of a Financial Institution; and (3) Satisfies the applicable federal and state regulatory and licensing requirements of banking, and securities laws with respect to the covered transaction. (b) ‘‘Affiliate’’ of an Adviser or Financial Institution means: (1) Any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution. For this purpose, the term ‘‘control’’ means the power to exercise a controlling influence over the management or policies of a person other than an individual; PO 00000 Frm 00193 Fmt 4701 Sfmt 4700 21137 (2) Any officer, director, partner, employee, or relative (as defined in ERISA section 3(15)) of the Adviser or Financial Institution; or (3) Any corporation or partnership of which the Adviser or Financial Institution is an officer, director, or partner of the Adviser or Financial Institution. (c) Investment advice is in the ‘‘Best Interest’’ of the Retirement Investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution, any Affiliate or other party. (d) ‘‘Debt Security’’ means a ‘‘debt security’’ as defined in Rule 10b– 10(d)(4) of the Exchange Act that is: (1) U.S. dollar denominated, issued by a U.S. corporation and offered pursuant to a registration statement under the Securities Act of 1933; (2) An ‘‘Agency Debt Security’’ as defined in FINRA rule 6710(l) or its successor; (3) An ‘‘Asset Backed Security’’ as defined in FINRA rule 6710(m) or its successor, that is guaranteed by an Agency as defined in FINRA rule 6710(k) or its successor, or a Government Sponsored Enterprise as defined in FINRA rule 6710(n) or its successor; or (4) A ‘‘U.S. Treasury Security’’ as defined in FINRA rule 6710(p) or its successor. (e) ‘‘Financial Institution’’ means the entity that (i) employs the Adviser or otherwise retains such individual as an independent contractor, agent or registered representative, and (ii) customarily purchases or sells Principal Traded Assets for its own account in the ordinary course of its business, and that is: (1) Registered as an investment adviser under the Investment Advisers Act of 1940 (15 U.S.C. 80b–1 et seq.) or under the laws of the state in which the adviser maintains its principal office and place of business; (2) A bank or similar financial institution supervised by the United States or state, or a savings association (as defined in section 3(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1813(b)(1))); and E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 21138 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations (3) A broker or dealer registered under the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.). (f) ‘‘Independent’’ means a person that: (1) Is not the Adviser or Financial Institution or an Affiliate; (2) Does not receive or is not projected to receive within the current federal income tax year, compensation or other consideration for his or her own account from the Adviser, Financial Institution or an Affiliate in excess of 2% of the person’s annual revenues based upon its prior income tax year; and (3) Does not have a relationship to or an interest in the Adviser, Financial Institution or an Affiliate that might affect the exercise of the person’s best judgment in connection with transactions described in this exemption. (g) ‘‘Individual Retirement Account’’ or ‘‘IRA’’ means any account or annuity described in Code section 4975(e)(1)(B) through (F), including, for example, an individual retirement account described in Code section 408(a) and a health savings account described in Code section 223(d). (h) A ‘‘Material Conflict of Interest’’ exists when an Adviser or Financial Institution has a financial interest that a reasonable person would conclude could affect the exercise of its best judgment as a fiduciary in rendering advice to a Retirement Investor. (i) ‘‘Plan’’ means an employee benefit plan described in ERISA section 3(3) and any plan described in Code section 4975(e)(1)(A). (j) ‘‘Principal Traded Asset’’ means: (1) For purposes of a purchase by a Plan, participant or beneficiary account, or IRA, (i) a Debt Security, as defined in subsection (d) above; (ii) a certificate of deposit (CD); (iii) an interest in a Unit Investment Trust, within the meaning of Section 4(2) of the Investment Company Act of 1940, as amended; or (iv) an investment that is permitted to be purchased under an individual exemption granted by the Department under ERISA section 408(a) and/or Code section 4975(c), after the effective date of this exemption, that provides relief for investment advice fiduciaries to engage in the purchase of the investment in a Principal Transaction or a Riskless Principal Transaction with a Plan or IRA under the same conditions as this exemption; and (2) for purposes of a sale by a Plan, participant or beneficiary account, or IRA, securities or other investment property. VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 (k) ‘‘Principal Transaction’’ means a purchase or sale of a Principal Traded Asset in which an Adviser or Financial Institution is purchasing from or selling to a Plan, participant or beneficiary account, or IRA on behalf of the Financial Institution’s own account or the account of a person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Financial Institution. For purposes of this definition, a Principal Transaction does not include a Riskless Principal Transaction as defined in Section VI(m). (l) ‘‘Retirement Investor’’ means: (1) A fiduciary of a non-participant directed Plan subject to Title I of ERISA or described in Code section 4975(c)(1)(A) with authority to make investment decisions for the Plan; (2) A participant or beneficiary of a Plan subject to Title I of ERISA or described in Code section 4975(c)(1)(A) with authority to direct the investment of assets in his or her Plan account or to take a distribution; or (3) The beneficial owner of an IRA acting on behalf of the IRA. (m) ‘‘Riskless Principal Transaction’’ means a transaction in which a Financial Institution, after having received an order from a Retirement Investor to buy or sell a Principal Traded Asset, purchases or sells the asset for the Financial Institution’s own account to offset the contemporaneous transaction with the Retirement Investor. Section VII—Transition Period for Exemption (a) In general. ERISA and the Internal Revenue Code prohibit fiduciary advisers to employee benefit plans (Plans) and individual retirement plans (IRAs) from receiving compensation that varies based on their investment recommendations. ERISA and the Code also prohibit fiduciaries from engaging in securities purchases and sales with Plans or IRAs on behalf of their own accounts (Principal Transactions). This transition period provides relief from the restrictions of ERISA section 406(a)(1)(A) and (D) and section 406(b)(1) and (2), and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(A), (D), and (E) for the period from April 10, 2017, to January 1, 2018 (the Transition Period) for Advisers and Financial Institutions to engage in certain Principal Transactions and Riskless Principal Transactions with Plans and IRAs subject to the conditions described in Section VII(d). (b) Covered transactions. This provision permits an Adviser or PO 00000 Frm 00194 Fmt 4701 Sfmt 4700 Financial Institution to engage in the purchase or sale of a Principal Traded Asset in a Principal Transaction or a Riskless Principal Transaction with a Plan, participant or beneficiary account, or IRA, and receive a mark-up, markdown or other similar payment as applicable to the transaction for themselves or any Affiliate, as a result of the Adviser’s and Financial Institution’s advice regarding the Principal Transaction or the Riskless Principal Transaction, during the Transition Period. (c) Exclusions. This provision does not apply if: (1) The Adviser: (i) Has or exercises any discretionary authority or discretionary control respecting management of the assets of the Plan or IRA involved in the transaction or exercises any discretionary authority or control respecting management or the disposition of the assets; or (ii) has any discretionary authority or discretionary responsibility in the administration of the Plan or IRA; or (2) The Plan is covered by Title I of ERISA, and (i) the Adviser, Financial Institution or any Affiliate is the employer of employees covered by the Plan, or (ii) the Adviser or Financial Institution is a named fiduciary or plan administrator (as defined in ERISA section 3(16)(A)) with respect to the Plan, or an Affiliate thereof, that was selected to provide advice to the Plan by a fiduciary who is not Independent; (d) Conditions. The provision is subject to the following conditions: (1) The Financial Institution and Adviser adhere to the following standards: (i) When providing investment advice to the Retirement Investor regarding the Principal Transaction or Riskless Principal Transaction, the Financial Institution and the Adviser(s) provide investment advice that is, at the time of the recommendation, in the Best Interest of the Retirement Investor. As further defined in Section VI(c), such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate or other party; (ii) The Adviser and Financial Institution will seek to obtain the best execution reasonably available under the circumstances with respect to the E:\FR\FM\08APR3.SGM 08APR3 mstockstill on DSK4VPTVN1PROD with RULES3 Federal Register / Vol. 81, No. 68 / Friday, April 8, 2016 / Rules and Regulations Principal Transaction or Riskless Principal Transaction. Financial Institutions that are FINRA members shall satisfy this requirement if they comply with the terms of FINRA rules 2121 (Fair Prices and Commissions) and 5310 (Best Execution and Interpositioning), or any successor rules in effect at the time of the transaction, as interpreted by FINRA, with respect to the Principal Transaction or Riskless Principal Transaction; and (iii) Statements by the Financial Institution and its Advisers to the Retirement Investor about the Principal Transaction or Riskless Principal Transaction, fees and compensation related to the Principal Transaction or Riskless Principal Transaction, Material Conflicts of Interest, and any other matters relevant to a Retirement Investor’s decision to engage in the Principal Transaction or Riskless Principal Transaction, are not materially misleading at the time they are made. (2) Disclosures. The Financial Institution provides to the Retirement Investor, prior to or at the same time as the execution of the recommended Principal Transaction or Riskless Principal Transaction, a single written disclosure, which may cover multiple transactions or all transactions occurring within the Transition Period, that clearly and prominently: (i) Affirmatively states that the Financial Institution and the Adviser(s) act as fiduciaries under ERISA or the Code, or both, with respect to the recommendation; (ii) Sets forth the standards in paragraph (d)(1) of this section and affirmatively states that it and the Adviser(s) adhered to such standards in recommending the transaction; and (iii) Discloses the circumstances under which the Adviser and Financial Institution may engage in Principal Transactions and Riskless Principal Transactions with the Plan, participant or beneficiary account, or IRA, and identifies and discloses the Material Conflicts of Interest associated with Principal Transactions and Riskless Principal Transactions. (iv) The disclosure may be provided in person, electronically or by mail. It does not have to be repeated for any subsequent recommendations during the Transition Period. (v) The Financial Institution will not fail to satisfy this Section VII(d)(2) solely because it, acting in good faith and with reasonable diligence, makes an error or omission in disclosing the required information, provided the Financial Institution discloses the correct information as soon as practicable, but not later than 30 days VerDate Sep<11>2014 20:29 Apr 07, 2016 Jkt 238001 after the date on which it discovers or reasonably should have discovered the error or omission. To the extent compliance with this Section VII(d)(2) requires Advisers and Financial Institutions to obtain information from entities that are not closely affiliated with them, they may rely in good faith on information and assurances from the other entities, as long as they do not know, or unless they should have known, that the materials are incomplete or inaccurate. This good faith reliance applies unless the entity providing the information to the Adviser and Financial Institution is (1) a person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Adviser or Financial Institution; or (2) any officer, director, employee, agent, registered representative, relative (as defined in ERISA section 3(15)), member of family (as defined in Code section 4975(e)(6)) of, or partner in, the Adviser or Financial Institution. (3) The Financial Institution must designate a person or persons, identified by name, title or function, responsible for addressing Material Conflicts of Interest and monitoring Advisers’ adherence to the Impartial Conduct Standards. (4) The Financial Institution complies with the recordkeeping requirements of Section V(a) and (b). 21139 Adoption of amendment to PTE 75–1, Part V. ACTION: 29 CFR Part 2550 This document contains an amendment to PTE 75–1, Part V, a class exemption from certain prohibited transactions provisions of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (the Code). The provisions at issue generally prohibit fiduciaries of employee benefit plans and individual retirement accounts (IRAs), from lending money or otherwise extending credit to the plans and IRAs and receiving compensation in return. PTE 75–1, Part V, permits the extension of credit to a plan or IRA by a brokerdealer in connection with the purchase or sale of securities; however, it originally did not permit the receipt of compensation for an extension of credit by broker-dealers that are fiduciaries with respect to the assets involved in the transaction. This amendment permits investment advice fiduciaries to receive compensation when they extend credit to plans and IRAs to avoid a failed securities transaction. The amendment affects participants and beneficiaries of plans, IRA owners, and fiduciaries with respect to such plans and IRAs. DATES: Issuance date: This amendment is issued June 7, 2016. Applicability date: This amendment is applicable to transactions occurring on or after April 10, 2017. See Applicability Date, below, for further information. FOR FURTHER INFORMATION CONTACT: Susan Wilker, Office of Exemption Determinations, Employee Benefits Security Administration, U.S. Department of Labor, (202) 693–8824 (this is not a toll-free number). SUPPLEMENTARY INFORMATION: The Department is amending PTE 75–1, Part V on its own motion, pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in accordance with the procedures set forth in 29 CFR part 2570, subpart B (76 FR 66637 (October 27, 2011)). [Application Number D–11687] Executive Summary Signed at Washington, DC, this 1st day of April, 2016. Phyllis C. Borzi, Assistant Secretary, Employee Benefits Security Administration, Department of Labor. [FR Doc. 2016–07926 Filed 4–6–16; 11:15 am] BILLING CODE 4510–29–P DEPARTMENT OF LABOR Employee Benefits Security Administration ZRIN 1210–ZA25 Amendment to Prohibited Transaction Exemption (PTE) 75–1, Part V, Exemptions From Prohibitions Respecting Certain Classes of Transactions Involving Employee Benefit Plans and Certain BrokerDealers, Reporting Dealers and Banks Employee Benefits Security Administration (EBSA), U.S. Department of Labor. AGENCY: PO 00000 Frm 00195 Fmt 4701 Sfmt 4700 SUMMARY: Purpose of Regulatory Action The Department grants this amendment to PTE 75–1, Part V, in connection with its publication today, elsewhere in this issue of the Federal Register, of a final regulation defining who is a ‘‘fiduciary’’ of an employee benefit plan under ERISA as a result of giving investment advice to a plan or its participants or beneficiaries (Regulation). The Regulation also applies to the definition of a ‘‘fiduciary’’ of a plan (including an IRA) under the E:\FR\FM\08APR3.SGM 08APR3

Agencies

[Federal Register Volume 81, Number 68 (Friday, April 8, 2016)]
[Rules and Regulations]
[Pages 21089-21139]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-07926]


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DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2550

[Application Number D-11713]
ZRIN 1210-ZA25


Class Exemption for Principal Transactions in Certain Assets 
Between Investment Advice Fiduciaries and Employee Benefit Plans and 
IRAs

AGENCY: Employee Benefits Security Administration (EBSA), U.S. 
Department of Labor.

ACTION: Adoption of Class Exemption.

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SUMMARY: This document contains an exemption from certain prohibited 
transactions provisions of the Employee Retirement Income Security Act 
of 1974 (ERISA) and the Internal Revenue Code (the Code). The 
provisions at issue generally prohibit fiduciaries with respect to 
employee benefit plans and individual retirement accounts (IRAs) from 
purchasing and selling investments when the fiduciaries are acting on 
behalf of their own accounts (principal transactions). The exemption 
permits principal transactions and riskless principal transactions in 
certain investments between a plan, plan participant or beneficiary 
account, or an IRA, and a fiduciary that provides investment advice to 
the plan or IRA, under conditions to safeguard the interests of these 
investors. The exemption affects participants and beneficiaries of 
plans, IRA owners, and fiduciaries with respect to such plans and IRAs.

DATES: 
    Issuance date: This exemption is issued June 7, 2016.
    Applicability date: This exemption is applicable to transactions 
occurring on or after April 10, 2017. See Section F of this preamble, 
Applicability Date and Transition Rules in this preamble, for further 
information.

FOR FURTHER INFORMATION CONTACT: Brian Shiker, Office of Exemption 
Determinations, Employee Benefits Security Administration, U.S. 
Department of Labor (202) 693-8824 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Executive Summary

Purpose of Regulatory Action

    The Department grants this exemption in connection with its 
publication today, elsewhere in this issue of the Federal Register, of 
a final regulation defining who is a ``fiduciary'' of an employee 
benefit plan under ERISA as a result of giving investment advice to a 
plan or its participants or beneficiaries (Regulation). The Regulation 
also applies to the definition of a ``fiduciary'' of a plan (including 
an IRA) under the Code. The Regulation amends a prior regulation, 
dating to 1975, specifying when a person is a ``fiduciary'' under ERISA 
and the Code by reason of the provision of investment advice for a fee 
or other compensation regarding assets of a plan or IRA. The Regulation 
takes into account the advent of 401(k) plans and IRAs, the dramatic 
increase in rollovers, and other developments that have transformed the 
retirement plan landscape and the associated investment market over the 
four decades since the existing regulation was issued. In light of the 
extensive changes in retirement investment practices and relationships, 
the Regulation updates existing rules to distinguish more appropriately 
between the sorts of advice relationships that should be treated as 
fiduciary in nature and those that should not.
    This exemption allows investment advice fiduciaries to engage in 
purchases and sales of certain investments out of their inventory 
(i.e., engage in principal transactions) with plans, participant or 
beneficiary accounts, and IRAs, under conditions designed to safeguard 
the interests of these investors. In the absence of an exemption, these 
transactions would be prohibited under ERISA and the Code. In this 
regard, ERISA and the Code generally prohibit fiduciaries with respect 
to plans and IRAs from purchasing or selling any property to plans, 
participant or beneficiary accounts, or IRAs. Fiduciaries also may not 
engage in self-dealing or, under ERISA, act in any transaction 
involving the plan on behalf of a party whose interests are adverse to 
the interests of the plan or the interests of its participants and 
beneficiaries. When a fiduciary purchases or sells an investment in a 
principal transaction or riskless principal transaction, it violates 
these prohibitions.
    ERISA section 408(a) specifically authorizes the Secretary of Labor 
to grant administrative exemptions from ERISA's prohibited transaction 
provisions.\1\ Regulations at 29 CFR 2570.30 to 2570.52 describe the 
procedures for applying for an administrative exemption. In granting 
this exemption, the Department has determined that the exemption is 
administratively feasible, in the interests of plans and their 
participants and beneficiaries and IRA owners, and protective of the 
rights of participants and beneficiaries of plans and IRA owners.
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    \1\ Code section 4975(c)(2) authorizes the Secretary of the 
Treasury to grant exemptions from the parallel prohibited 
transaction provisions of the Code. Reorganization Plan No. 4 of 
1978 (5 U.S.C. app. at 214 (2000)) (Reorganization Plan) generally 
transferred the authority of the Secretary of the Treasury to grant 
administrative exemptions under Code section 4975 to the Secretary 
of Labor. To rationalize the administration and interpretation of 
dual provisions under ERISA and the Code, the Reorganization Plan 
divided the interpretive and rulemaking authority for these 
provisions between the Secretaries of Labor and of the Treasury, so 
that, in general, the agency with responsibility for a given 
provision of Title I of ERISA would also have responsibility for the 
corresponding provision in the Code. Among the sections transferred 
to the Department were the prohibited transaction provisions and the 
definition of a fiduciary in both Title I of ERISA and in the Code. 
ERISA's prohibited transaction rules, 29 U.S.C. 1106-1108, apply to 
ERISA-covered plans, and the Code's corresponding prohibited 
transaction rules, 26 U.S.C. 4975(c), apply both to ERISA-covered 
pension plans that are tax-qualified pension plans, as well as other 
tax-advantaged arrangements, such as IRAs, that are not subject to 
the fiduciary responsibility and prohibited transaction rules in 
ERISA. Specifically, section 102(a) of the Reorganization Plan 
provides the Department of Labor with ``all authority'' for 
''regulations, rulings, opinions, and exemptions under section 4975 
[of the Code]'' subject to certain exceptions not relevant here. 
Reorganization Plan section 102. In President Carter's message to 
Congress regarding the Reorganization Plan, he made explicitly clear 
that as a result of the plan, ``Labor will have statutory authority 
for fiduciary obligations. . . . Labor will be responsible for 
overseeing fiduciary conduct under these provisions.'' 
Reorganization Plan, Message of the President. This exemption 
provides relief from the indicated prohibited transaction provisions 
of both ERISA and the Code.
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Summary of the Major Provisions

    The exemption allows an individual investment advice fiduciary (an 
Adviser) \2\ and the firm that employs or otherwise contracts with the 
Adviser (a Financial Institution) to engage in principal transactions 
and riskless principal transactions involving certain investments, with 
plans, participant and beneficiary accounts, and IRAs. The exemption 
limits the type of investments that may be purchased or sold and 
contains conditions which the

[[Page 21090]]

Adviser and Financial Institution must satisfy in order to rely on the 
exemption. To safeguard the interests of plans, participants and 
beneficiaries, and IRA owners, the exemption requires Financial 
Institutions to give the appropriate fiduciary of the plan or IRA owner 
a written statement in which the Financial Institution acknowledges its 
fiduciary status and that of its Advisers. The Financial Institution 
and Adviser must adhere to enforceable standards of fiduciary conduct 
and fair dealing when providing investment advice regarding the 
transaction to Retirement Investors. In the case of IRAs and non-ERISA 
plans, the exemption requires that these standards be set forth in an 
enforceable contract with the Retirement Investor. Under the 
exemption's terms, Financial Institutions are not required to enter 
into a contract with ERISA plan investors, but they are obligated to 
acknowledge fiduciary status in writing, and adhere to these same 
standards of fiduciary conduct, which the investors can effectively 
enforce pursuant to section 502(a)(2) and (3) of ERISA. Under this 
standards-based approach, the Adviser and Financial Institution must 
give prudent advice that is in the customer's Best Interest, avoid 
misleading statements, and seek to obtain the best execution reasonably 
available under the circumstances with respect to the transaction. 
Additionally, Financial Institutions must adopt policies and procedures 
reasonably designed to mitigate any harmful impact of conflicts of 
interest, and must disclose their conflicts of interest to Retirement 
Investors.
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    \2\ By using the term ``Adviser,'' the Department does not 
intend to limit the exemption to investment advisers registered 
under the Investment Advisers Act of 1940 or under state law. As 
explained herein, an Adviser must be an investment advice fiduciary 
of a plan or IRA who is an employee, independent contractor, agent, 
or registered representative of a registered investment adviser, 
bank, or registered broker-dealer.
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    The exemption is calibrated to align the Adviser's interests with 
those of the plan or IRA customer, while leaving the Adviser and the 
Financial Institution the flexibility and discretion necessary to 
determine how best to satisfy the exemption's standards in light of the 
unique attributes of their business. Financial Institutions relying on 
the exemption must obtain the Retirement Investor's consent to 
participate in principal transactions and riskless principal 
transactions, and the Financial Institutions are subject to 
recordkeeping requirements.

Executive Order 12866 and 13563 Statement

    Under Executive Orders 12866 and 13563, the Department must 
determine whether a regulatory action is ``significant'' and therefore 
subject to the requirements of the Executive Order and subject to 
review by the Office of Management and Budget (OMB). Executive Orders 
12866 and 13563 direct agencies to assess all costs and benefits of 
available regulatory alternatives and, if regulation is necessary, to 
select regulatory approaches that maximize net benefits (including 
potential economic, environmental, public health and safety effects, 
distributive impacts, and equity). Executive Order 13563 emphasizes the 
importance of quantifying both costs and benefits, of reducing costs, 
of harmonizing and streamlining rules, and of promoting flexibility. It 
also requires federal agencies to develop a plan under which the 
agencies will periodically review their existing significant 
regulations to make the agencies' regulatory programs more effective or 
less burdensome in achieving their regulatory objectives.
    Under Executive Order 12866, ``significant'' regulatory actions are 
subject to the requirements of the Executive Order and review by the 
OMB. Section 3(f) of Executive Order 12866, defines a ``significant 
regulatory action'' as an action that is likely to result in a rule (1) 
having an annual effect on the economy of $100 million or more, or 
adversely and materially affecting a sector of the economy, 
productivity, competition, jobs, the environment, public health or 
safety, or State, local or tribal governments or communities (also 
referred to as ``economically significant'' regulatory actions); (2) 
creating serious inconsistency or otherwise interfering with an action 
taken or planned by another agency; (3) materially altering the 
budgetary impacts of entitlement grants, user fees, or loan programs or 
the rights and obligations of recipients thereof; or (4) raising novel 
legal or policy issues arising out of legal mandates, the President's 
priorities, or the principles set forth in the Executive Order. 
Pursuant to the terms of the Executive Order, OMB has determined that 
this action is ``significant'' within the meaning of Section 3(f)(1) of 
the Executive Order. Accordingly, the Department has undertaken an 
assessment of the costs and benefits of the proposal, and OMB has 
reviewed this regulatory action. The Department's complete Regulatory 
Impact Analysis is available at www.dol.gov/ebsa.

I. Background

    The Department proposed this class exemption on its own motion, 
pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in 
accordance with the procedures set forth in 29 CFR part 2570, subpart B 
(76 FR 66637 (October 27, 2011)).

A. Regulation Defining a Fiduciary

    As explained more fully in the preamble to the Regulation, ERISA is 
a comprehensive statute designed to protect the interests of plan 
participants and beneficiaries, the integrity of employee benefit 
plans, and the security of retirement, health, and other critical 
benefits. The broad public interest in ERISA-covered plans is reflected 
in its imposition of stringent fiduciary responsibilities on parties 
engaging in important plan activities, as well as in the tax-favored 
status of plan assets and investments. One of the chief ways in which 
ERISA protects employee benefit plans is by requiring that plan 
fiduciaries comply with fundamental obligations rooted in the law of 
trusts. In particular, plan fiduciaries must manage plan assets 
prudently and with undivided loyalty to the plans and their 
participants and beneficiaries.\3\ In addition, they must refrain from 
engaging in ``prohibited transactions,'' which ERISA does not permit 
because of the dangers posed by the fiduciaries' conflicts of interest 
with respect to the transactions.\4\ When fiduciaries violate ERISA's 
fiduciary duties or the prohibited transaction rules, they may be held 
personally liable for the breach.\5\ In addition, violations of the 
prohibited transaction rules are subject to excise taxes under the 
Code.
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    \3\ ERISA section 404(a).
    \4\ ERISA section 406. ERISA also prohibits certain transactions 
between a plan and a party in interest.
    \5\ ERISA section 409; see also ERISA section 405.
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    The Code also has rules regarding fiduciary conduct with respect to 
tax-favored accounts that are not generally covered by ERISA, such as 
IRAs. In particular, fiduciaries of these arrangements, including IRAs, 
are subject to the prohibited transaction rules and, when they violate 
the rules, to the imposition of an excise tax enforced by the Internal 
Revenue Service. Unlike participants in plans covered by Title I of 
ERISA, IRA owners do not have a statutory right to bring suit against 
fiduciaries for violations of the prohibited transaction rules.
    Under this statutory framework, the determination of who is a 
``fiduciary'' is of central importance. Many of ERISA's and the Code's 
protections, duties, and liabilities hinge on fiduciary status. In 
relevant part, ERISA section 3(21)(A) and Code section 4975(e)(3) 
provide that a person is a fiduciary with respect to a plan or IRA to 
the extent he or she (i) exercises any discretionary authority or 
discretionary control with respect to management of such plan or IRA, 
or exercises any authority or control with respect to management or 
disposition of

[[Page 21091]]

its assets; (ii) renders investment advice for a fee or other 
compensation, direct or indirect, with respect to any moneys or other 
property of such plan or IRA, or has any authority or responsibility to 
do so; or, (iii) has any discretionary authority or discretionary 
responsibility in the administration of such plan or IRA.
    The statutory definition deliberately casts a wide net in assigning 
fiduciary responsibility with respect to plan and IRA assets. Thus, 
``any authority or control'' over plan or IRA assets is sufficient to 
confer fiduciary status, and any persons who render ``investment advice 
for a fee or other compensation, direct or indirect'' are fiduciaries, 
regardless of whether they have direct control over the plan's or IRA's 
assets and regardless of their status as an investment adviser or 
broker under the federal securities laws. The statutory definition and 
associated responsibilities were enacted to ensure that plans, plan 
participants and IRA owners can depend on persons who provide 
investment advice for a fee to provide recommendations that are 
untainted by conflicts of interest. In the absence of fiduciary status, 
the providers of investment advice are neither subject to ERISA's 
fundamental fiduciary standards, nor accountable under ERISA or the 
Code for imprudent, disloyal, or biased advice.
    In 1975, the Department issued a regulation, at 29 CFR 2510.3-
21(c)(1975) defining the circumstances under which a person is treated 
as providing ``investment advice'' to an employee benefit plan within 
the meaning of section 3(21)(A)(ii) of ERISA (the 1975 regulation).\6\ 
The 1975 regulation narrowed the scope of the statutory definition of 
fiduciary investment advice by creating a five-part test for fiduciary 
advice. Under the 1975 regulation, for advice to constitute 
``investment advice,'' an adviser must--(1) render advice as to the 
value of securities or other property, or make recommendations as to 
the advisability of investing in, purchasing or selling securities or 
other property (2) on a regular basis (3) pursuant to a mutual 
agreement, arrangement or understanding, with the plan or a plan 
fiduciary that (4) the advice will serve as a primary basis for 
investment decisions with respect to plan assets, and that (5) the 
advice will be individualized based on the particular needs of the 
plan. The 1975 regulation provided that an adviser is a fiduciary with 
respect to any particular instance of advice only if he or she meets 
each and every element of the five-part test with respect to the 
particular advice recipient or plan at issue.
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    \6\ The Department of Treasury issued a virtually identical 
regulation, at 26 CFR 54.4975-9(c), which interprets Code section 
4975(e)(3).
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    The market for retirement advice has changed dramatically since the 
Department first promulgated the 1975 regulation. Individuals, rather 
than large employers and professional money managers, have become 
increasingly responsible for managing retirement assets as IRAs and 
participant-directed plans, such as 401(k) plans, have supplanted 
defined benefit pensions. At the same time, the variety and complexity 
of financial products have increased, widening the information gap 
between advisers and their clients. Plan fiduciaries, plan participants 
and IRA investors must often rely on experts for advice, but are unable 
to assess the quality of the expert's advice or effectively guard 
against the adviser's conflicts of interest. This challenge is 
especially true of retail investors, who typically do not have 
financial expertise and can ill-afford lower returns to their 
retirement savings caused by conflicts. The IRA accounts of these 
investors often account for all or the lion's share of their assets, 
and can represent all of savings earned for a lifetime of work. Losses 
and reduced returns can be devastating to the investors who depend upon 
such savings for support in their old age. As baby boomers retire, they 
are increasingly moving money from ERISA-covered plans, where their 
employer has both the incentive and the fiduciary duty to facilitate 
sound investment choices, to IRAs where both good and bad investment 
choices are myriad and advice that is conflicted is commonplace. These 
rollovers are expected to approach $2.4 trillion cumulatively from 2016 
through 2020.\7\ These trends were not apparent when the Department 
promulgated the 1975 regulation. At that time, 401(k) plans did not yet 
exist and IRAs had only just been authorized.
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    \7\ Cerulli Associates, ``Retirement Markets 2015.''
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    As the marketplace for financial services has developed in the 
years since 1975, the five-part test has now come to undermine, rather 
than promote, the statutes' text and purposes. The narrowness of the 
1975 regulation has allowed advisers, brokers, consultants and 
valuation firms to play a central role in shaping plan and IRA 
investments, without ensuring the accountability that Congress intended 
for persons having such influence and responsibility. Even when plan 
sponsors, participants, beneficiaries, and IRA owners clearly relied on 
paid advisers for impartial guidance, the 1975 regulation has allowed 
many advisers to avoid fiduciary status and disregard basic fiduciary 
obligations of care and prohibitions on disloyal and conflicted 
transactions. As a consequence, these advisers have been able to steer 
customers to investments based on their own self-interest (e.g., 
products that generate higher fees for the adviser even if there are 
identical lower-fee products available), give imprudent advice, and 
engage in transactions that would otherwise be prohibited by ERISA and 
the Code without fear of accountability under either ERISA or the Code.
    In the Department's amendments to the 1975 regulation defining 
fiduciary advice within the meaning of ERISA section 3(21)(A)(ii) and 
Code section 4975(e)(3)(B) (the Regulation), which are also published 
in this issue of the Federal Register, the Department is replacing the 
existing regulation with one that more appropriately distinguishes 
between the sorts of advice relationships that should be treated as 
fiduciary in nature and those that should not, in light of the legal 
framework and financial marketplace in which IRAs and plans currently 
operate.\8\
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    \8\ The Department initially proposed an amendment to its 
regulation defining a fiduciary within the meaning of ERISA section 
3(21)(A)(ii) and Code section 4975(e)(3)(B) on October 22, 2010, at 
75 FR 65263. It subsequently announced its intention to withdraw the 
proposal and propose a new rule, consistent with the President's 
Executive Orders 12866 and 13563, in order to give the public a full 
opportunity to evaluate and comment on the new proposal and updated 
economic analysis. The first proposed amendment to the rule was 
withdrawn on April 20, 2015, see 80 FR 21927.
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    The Regulation describes the types of advice that constitute 
``investment advice'' with respect to plan or IRA assets for purposes 
of the definition of a fiduciary at ERISA section 3(21)(A)(ii) and Code 
section 4975(e)(3)(B). The Regulation covers ERISA-covered plans, IRAs, 
and other plans not covered by Title I, such as Keogh plans, and health 
savings accounts described in Code section 223(d).
    As amended, the Regulation provides that a person renders 
investment advice with respect to assets of a plan or IRA if, among 
other things, the person provides, directly to a plan, a plan 
fiduciary, plan participant or beneficiary, IRA or IRA owner, the 
following types of advice, for a fee or other compensation, whether 
direct or indirect:
    (i) A recommendation as to the advisability of acquiring, holding, 
disposing of, or exchanging, securities or other investment property, 
or a

[[Page 21092]]

recommendation as to how securities or other investment property should 
be invested after the securities or other investment property are 
rolled over, transferred or distributed from the plan or IRA; and
    (ii) A recommendation as to the management of securities or other 
investment property, including, among other things, recommendations on 
investment policies or strategies, portfolio composition, selection of 
other persons to provide investment advice or investment management 
services, types of investment account arrangements (brokerage versus 
advisory), or recommendations with respect to rollovers, transfers or 
distributions from a plan or IRA, including whether, in what amount, in 
what form, and to what destination such a rollover, transfer or 
distribution should be made.
    In addition, in order to be treated as a fiduciary, such person, 
either directly or indirectly (e.g., through or together with any 
Affiliate), must: Represent or acknowledge that it is acting as a 
fiduciary within the meaning of ERISA or the Code with respect to the 
advice described; represent or acknowledge that it is acting as a 
fiduciary within the meaning of ERISA or the Code; render the advice 
pursuant to a written or verbal agreement, arrangement or understanding 
that the advice is based on the particular investment needs of the 
advice recipient; or direct the advice to a specific advice recipient 
or recipients regarding the advisability of a particular investment or 
management decision with respect to securities or other investment 
property of the plan or IRA.
    The Regulation also provides that as a threshold matter in order to 
be fiduciary advice, the communication must be a ``recommendation'' as 
defined therein. The Regulation, as a matter of clarification, provides 
that a variety of other communications do not constitute 
``recommendations,'' including non-fiduciary investment education; 
general communications; and specified communications by platform 
providers. These communications which do not rise to the level of 
``recommendations'' under the Regulation are discussed more fully in 
the preamble to the final Regulation.
    The Regulation also specifies certain circumstances where the 
Department has determined that a person will not be treated as an 
investment advice fiduciary even though the person's activities 
technically may satisfy the definition of investment advice. For 
example, the Regulation contains a provision excluding recommendations 
to independent fiduciaries with financial expertise that are acting on 
behalf of plans or IRAs in arm's length transactions, if certain 
conditions are met. The independent fiduciary must be a bank, insurance 
carrier qualified to do business in more than one state, investment 
adviser registered under the Investment Advisers Act of 1940 or by a 
state, broker-dealer registered under the Securities Exchange Act of 
1934 (Exchange Act), or any other independent fiduciary that holds, or 
has under management or control, assets of at least $50 million, and: 
(1) The person making the recommendation must know or reasonably 
believe that the independent fiduciary of the plan or IRA is capable of 
evaluating investment risks independently, both in general and with 
regard to particular transactions and investment strategies (the person 
may rely on written representations from the plan or independent 
fiduciary to satisfy this condition); (2) the person must fairly inform 
the independent fiduciary that the person is not undertaking to provide 
impartial investment advice, or to give advice in a fiduciary capacity, 
in connection with the transaction and must fairly inform the 
independent fiduciary of the existence and nature of the person's 
financial interests in the transaction; (3) the person must know or 
reasonably believe that the independent fiduciary of the plan or IRA is 
a fiduciary under ERISA or the Code, or both, with respect to the 
transaction and is responsible for exercising independent judgment in 
evaluating the transaction (the person may rely on written 
representations from the plan or independent fiduciary to satisfy this 
condition); and (4) the person cannot receive a fee or other 
compensation directly from the plan, plan fiduciary, plan participant 
or beneficiary, IRA, or IRA owner for the provision of investment 
advice (as opposed to other services) in connection with the 
transaction.
    Similarly, the Regulation provides that the provision of any advice 
to an employee benefit plan (as described in ERISA section 3(3)) by a 
person who is a swap dealer, security-based swap dealer, major swap 
participant, major security-based swap participant, or a swap clearing 
firm in connection with a swap or security-based swap, as defined in 
section 1a of the Commodity Exchange Act (7 U.S.C. 1a) and section 3(a) 
of the Exchange Act (15 U.S.C. 78c(a)) is not investment advice if 
certain conditions are met. Finally, the Regulation describes certain 
communications by employees of a plan sponsor, plan, or plan fiduciary 
that would not cause the employee to be an investment advice fiduciary 
if certain conditions are met.

B. Prohibited Transactions

    The Department anticipates that the Regulation will cover many 
investment professionals who did not previously consider themselves to 
be fiduciaries under ERISA or the Code. Under the Regulation, these 
entities will be subject to the prohibited transaction restrictions in 
ERISA and the Code that apply specifically to fiduciaries. ERISA 
section 406(b)(1) and Code section 4975(c)(1)(E) prohibit a fiduciary 
from dealing with the income or assets of a plan or IRA in his own 
interest or his own account. ERISA section 406(b)(2), which does not 
apply to IRAs, provides that a fiduciary shall not ``in his individual 
or in any other capacity act in any transaction involving the plan on 
behalf of a party (or represent a party) whose interests are adverse to 
the interests of the plan or the interests of its participants or 
beneficiaries.'' ERISA section 406(b)(3) and Code section 4975(c)(1)(F) 
prohibit a fiduciary from receiving any consideration for his own 
personal account from any party dealing with the plan or IRA in 
connection with a transaction involving assets of the plan or IRA.
    Parallel regulations issued by the Departments of Labor and the 
Treasury explain that these provisions impose on fiduciaries of plans 
and IRAs a duty not to act on conflicts of interest that may affect the 
fiduciary's best judgment on behalf of the plan or IRA.\9\ The 
prohibitions extend to a fiduciary causing a plan or IRA to pay an 
additional fee to such fiduciary, or to a person in which such 
fiduciary has an interest that may affect the exercise of the 
fiduciary's best judgment as a fiduciary. Likewise, a fiduciary is 
prohibited from receiving compensation from third parties in connection 
with a transaction involving the plan or IRA.\10\
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    \9\ Subsequent to the issuance of these regulations, 
Reorganization Plan No. 4 of 1978, 5 U.S.C. App. (2010), divided 
rulemaking and interpretive authority between the Secretaries of 
Labor and the Treasury. The Secretary of Labor was given 
interpretive and rulemaking authority regarding the definition of 
fiduciary under both Title I of ERISA and the Internal Revenue Code. 
Id. section 102(a) (``all authority of the Secretary of the Treasury 
to issue [regulations, rulings opinions, and exemptions under 
section 4975 of the Code] is hereby transferred to the Secretary of 
Labor'').
    \10\ 29 CFR 2550.408b-2(e); 26 CFR 54.4975-6(a)(5).
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    The purchase or sale of an investment in a principal transaction or 
riskless principal transaction between a plan or IRA and a fiduciary, 
resulting from the fiduciary's provision of investment advice, 
implicates the prohibited

[[Page 21093]]

transaction rules set forth in ERISA section 406(b) and Code section 
4975(c)(1)(E).\11\ Nevertheless, the Department recognizes that certain 
investment advice fiduciaries view the ability to execute principal 
transactions or riskless principal transaction as integral to the 
economically efficient distribution of fixed income securities. 
Therefore, in connection with the Regulation, the Department reviewed 
the existing legal framework to determine whether additional exemptions 
were needed for investment advice fiduciaries to engage in these 
transactions. In this regard, as further discussed below, fiduciaries 
who engage in such transactions under certain circumstances can avoid 
the ERISA and Code restrictions. Moreover, there are existing statutory 
and administrative exemptions, also discussed below, that already 
provide prohibited transaction relief for fiduciaries engaging in 
principal transactions and riskless principal transactions with plans 
and IRAs. Nevertheless, the Department determined that additional 
relief in this area is necessary and therefore, after reviewing the 
comments on the proposal, determined to grant this exemption for 
investment advice fiduciaries to engage in certain principal 
transactions and riskless principal transactions with plans and IRAs.
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    \11\ The purchase or sale of an investment in a principal 
transaction or a riskless principal transaction between a plan or 
IRA and a fiduciary also is prohibited by ERISA section 406(a)(1)(A) 
and (D) and Code section 4975(c)(1)(A) and (D).
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1. Blind Transactions
    Certain principal transactions and riskless principal transactions 
between a plan or IRA and an investment advice fiduciary may not need 
exemptive relief because they are blind transactions executed on an 
exchange. The ERISA Conference Report states that a transaction will, 
generally, not be a prohibited transaction if the transaction is an 
ordinary ``blind'' purchase or sale of securities through an exchange 
where neither the buyer nor the seller (nor the agent of either) knows 
the identity of the other party involved.\12\
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    \12\ See H.R. Rep. 93-1280, 93rd Cong., 2d Sess. 307 (1974); see 
also ERISA Advisory Opinion 2004-05A (May 24, 2004).
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2. Principal Transactions Permitted Under an Exemption
    As the prohibited transaction provisions demonstrate, ERISA and the 
Code strongly disfavor conflicts of interest. In appropriate cases, 
however, the statutes provide exemptions from their broad prohibitions 
on conflicts of interest. In addition, the Secretary of Labor has 
discretionary authority to grant administrative exemptions under ERISA 
and the Code on an individual or class basis, but only if the Secretary 
first finds that the exemptions are (1) administratively feasible, (2) 
in the interests of plans and their participants and beneficiaries and 
IRA owners, and (3) protective of the rights of the participants and 
beneficiaries of such plans and IRA owners. Accordingly, fiduciary 
advisers may always give advice without need of an exemption if they 
avoid the sorts of conflicts of interest that result in prohibited 
transactions. However, when they choose to give advice in which they 
have a conflict of interest, they must rely upon an exemption.
a. Statutory Exemptions
    ERISA section 408(b)(14) provides a statutory exemption for 
transactions entered into in connection with the provision of fiduciary 
investment advice to a participant or beneficiary of an individual 
account plan or an IRA owner. The exemption provides relief for, among 
other things, the acquisition, holding, or sale of a security or other 
property as an investment under the plan pursuant to the investment 
advice. As set forth in ERISA section 408(g), the exemption is 
available if the advice is provided under an ``eligible investment 
advice arrangement'' which either (1) ``provides that any fees 
(including any commission or other compensation) received by the 
fiduciary adviser for investment advice or with respect to the sale, 
holding or acquisition of any security or other property for purposes 
of investment of plan assets do not vary depending on the basis of any 
investment option selected'' or (2) ``uses a computer model under an 
investment advice program meeting the requirements of [ERISA section 
408(g)(3)].'' The ERISA section 408(g) exemptions include special 
conditions calibrated to insulate the fiduciary adviser from conflicts 
of interest. Code section 4975(d)(17) provides the same relief from the 
taxes imposed by Code section 4975(a) and (b).
    ERISA section 408(b)(16) provides relief for transactions involving 
the purchase or sale of securities between a plan and a party in 
interest, including an investment advice fiduciary, if the transactions 
are executed through an electronic communication network, alternative 
trading system, or similar execution system or trading venue. Among 
other conditions, subparagraph (B) of the statutory exemption requires 
that either: (i) ``the transaction is effected pursuant to rules 
designed to match purchases and sales at the best price available 
through the execution system in accordance with applicable rules of the 
Securities and Exchange Commission or other relevant governmental 
authority,'' or (ii) ``neither the execution system nor the parties to 
the transaction take into account the identity of the parties in the 
execution of trades[.]'' The transactions covered by ERISA section 
408(b)(16) include principal transactions between a plan and an 
investment advice fiduciary. Code section 4975(d)(19) provides the same 
relief from the taxes imposed by Code section 4975(a) and (b).
b. Administrative Exemptions
    An administrative exemption for certain principal transactions will 
continue to be available through PTE 75-1.\13\ Specifically, PTE 75-1, 
Part IV, provides an exemption that is available to investment advice 
fiduciaries who are ``market-makers.'' Relief is available from ERISA 
section 406 for the purchase or sale of securities by a plan or IRA, 
from or to a market-maker with respect to such securities who is also 
an investment advice fiduciary with respect to the plan or IRA, or an 
affiliate of such fiduciary. However, PTE 75-1, Part IV, is amended 
today in a Notice, published elsewhere in this issue of the Federal 
Register, to require fiduciaries relying on the exemption to comply 
with the Impartial Conduct Standards that are also incorporated in this 
exemption.
---------------------------------------------------------------------------

    \13\ 40 FR 50845 (Oct. 31, 1975), as amended, 71 FR 5883 (Feb. 
3, 2006).
---------------------------------------------------------------------------

    Further, Part II(1) of PTE 75-1 provides relief from ERISA section 
406(a) and Code section 4975(c)(1)(A) through (D) for the purchase or 
sale of a security in a principal transaction between a plan or IRA and 
a broker-dealer registered under the Exchange Act or a bank supervised 
by the United States or a state. However, the exemption permits plans 
and IRAs to engage in principal transactions with broker-dealers and 
banks only if the broker-dealers and banks do not have or exercise any 
discretionary authority or control (except as a directed trustee) with 
respect to the investment of plan or IRA assets involved in the 
transaction, and do not render investment advice (within the meaning of 
29 CFR 2510.3-21(c)) with respect to the investment of those assets. 
PTE 75-1, Part II(1) will continue to be available to parties in 
interest that are not fiduciaries and that satisfy its conditions. In 
this regard, the Regulation provides that parties will not be 
investment advice fiduciaries if they engage in arm's length 
transactions with

[[Page 21094]]

certain independent fiduciaries of a plan or IRA with financial 
expertise, including banks, insurance carriers, registered investment 
advisers, broker-dealers and persons holding, or possessing under 
management or control, total assets of at least $50 million, and who 
are capable of evaluating investment risks independently, both in 
general and with regard to particular transactions and investment 
strategies, and certain other conditions are satisfied. These non-
fiduciary counterparties can continue to rely on PTE 75-1, Part II, for 
relief regarding principal transactions.
    In connection with the proposed Regulation, the Department 
recognized the need for additional relief. Accordingly, the Department 
proposed this exemption for principal transactions in certain debt 
securities between a plan, participant or beneficiary account, or IRA, 
and an investment advice fiduciary. The proposed exemption was intended 
to facilitate continued access by plan and IRA investors to certain 
types of investments commonly sold in principal transactions.
    The Department also proposed the Best Interest Contract Exemption, 
which is adopted elsewhere in this issue of the Federal Register. The 
Best Interest Contract Exemption provides broad relief for investment 
advice fiduciaries and their Affiliates and related entities to receive 
compensation as a result of investment advice to retail Retirement 
Investors (plan participants and beneficiaries, IRA owners, and certain 
plan fiduciaries, including small plan sponsors) under conditions 
specifically designed to address the conflicts of interest associated 
with the wide variety of payments advisers receive in connection with 
retail transactions involving plans and IRAs.
    At the same time that the Department has granted these new 
exemptions, it has also amended existing exemptions to ensure uniform 
application of the Impartial Conduct Standards, which are fundamental 
obligations of fair dealing and fiduciary conduct, and include 
obligations to act in the customer's Best Interest, avoid misleading 
statements, and receive no more than reasonable compensation.\14\ Taken 
together, the new exemptions and amendments to existing exemptions 
ensure that Retirement Investors are consistently protected by 
Impartial Conduct Standards, regardless of the particular exemption 
upon which the adviser relies.
---------------------------------------------------------------------------

    \14\ The amended exemptions, published elsewhere in this Federal 
Register, include Prohibited Transaction Exemption (PTE) 75-1; PTE 
77-4; PTE 80-83; PTE 83-1: PTE 84-24; and PTE 86-128.
---------------------------------------------------------------------------

    The amendments also revoke certain existing exemptions, which 
provided little or no protections to IRA and non-ERISA plan 
participants, in favor of a more uniform application of the Best 
Interest Contract Exemption in the market for retail investments. With 
limited exceptions, it is the Department's intent that investment 
advice fiduciaries in the retail investment market rely on statutory 
exemptions, the Best Interest Contract Exemption, or this exemption to 
the extent that they receive conflicted forms of compensation that 
would otherwise be prohibited. The new and amended exemptions reflect 
the Department's view that Retirement Investors should be protected by 
a more consistent application of fundamental fiduciary standards across 
a wide range of investment products and advice relationships, and that 
retail investors, in particular, should be protected by the stringent 
protections set forth in the Best Interest Contract Exemption and this 
exemption. When fiduciaries have conflicts of interest, they will 
uniformly be expected to adhere to fiduciary norms and to make 
recommendations that are in their customer's Best Interest.
    These new and amended exemptions follow a lengthy public notice and 
comment process, which gave interested persons an extensive opportunity 
to comment on this proposed exemption, proposed Regulation and other 
related exemption proposals. The proposals initially provided for 75-
day comment periods, ending on July 6, 2015, but the Department 
extended the comment periods to July 21, 2015. The Department then held 
four days of public hearings on the new regulatory package, including 
the proposed exemptions, in Washington, DC from August 10 to 13, 2015, 
at which over 75 speakers testified. The transcript of the hearing was 
made available on September 8, 2015, and the Department provided 
additional opportunity for interested persons to comment on the 
proposals or hearing transcript until September 24, 2015. A total of 
over 3000 comment letters were received on the new proposals. There 
were also over 300,000 submissions made as part of 30 separate 
petitions submitted on the proposal. These comments and petitions came 
from consumer groups, plan sponsors, financial services companies, 
academics, elected government officials, trade and industry 
associations, and others, both in support and in opposition to the 
rule.\15\ The Department has reviewed all comments, and after careful 
consideration of the comments, has decided to grant this exemption.
---------------------------------------------------------------------------

    \15\ As used throughout this preamble, the term ``comment'' 
refers to information provided through these various sources, 
including written comments, petitions and witnesses at the public 
hearing.
---------------------------------------------------------------------------

II. Exemption for Principal Transactions in Certain Assets

    As finalized, this exemption for certain principal transactions and 
riskless principal transactions retains the core protections of the 
proposed exemption, but with revisions designed to facilitate 
implementation and compliance with the exemption's terms. In broadest 
outline, the exemption permits Advisers and the Financial Institutions 
that employ or otherwise retain them to enter into principal 
transactions and riskless principal transactions with plans and IRAs 
regarding certain investments, provided that they give advice regarding 
the transactions that is in their customers' Best Interest and the 
Financial Institution implements basic protections against the dangers 
posed by conflicts of interest. In particular, to rely on the 
exemption, Financial Institutions must:
     Acknowledge fiduciary status with respect to any 
investment advice regarding principal transactions or riskless 
principal transactions;
     Adhere to Impartial Conduct Standards requiring them to
    [cir] Give advice that is in the Retirement Investor's Best 
Interest (i.e., prudent advice that is based on the investment 
objectives, risk tolerance, financial circumstances, and needs of the 
Retirement Investor, without regard to financial or other interests of 
the Adviser, Financial Institution or any Affiliates or other parties);
    [cir] Seek to obtain the best execution reasonably available under 
the circumstances with respect to the transaction; and
    [cir] Make no misleading statements about investment transactions, 
compensation, and conflicts of interest;
     Implement policies and procedures reasonably and prudently 
designed to prevent violations of the Impartial Conduct Standards;
     Refrain from giving or using incentives for Advisers to 
act contrary to the customer's Best Interest; and
     Make additional disclosures.

Advisers relying on the exemption must comply with the Impartial 
Conduct Standards when making investment recommendations regarding 
principal transactions and riskless principal transactions.

[[Page 21095]]

    The exemption takes a principles-based approach that permits 
Financial Institutions and Advisers to enter into transactions that 
would otherwise be prohibited. The exemption holds Financial 
Institutions and their Advisers responsible for adhering to fundamental 
standards of fiduciary conduct and fair dealing, while leaving them the 
flexibility and discretion necessary to determine how best to satisfy 
these basic standards in light of the unique attributes of their 
particular businesses. The exemption's principles-based conditions, 
which are rooted in the law of trust and agency, have the breadth and 
flexibility necessary to apply to a large range of investment and 
compensation practices, while ensuring that Advisers put the interests 
of Retirement Investors first. When Advisers choose to give advice 
regarding principal transactions and riskless principal transactions to 
Retirement Investors, they must protect their customers from the 
dangers posed by conflicts of interest.
    In order to ensure compliance with the exemption's broad protective 
standards and purposes, the exemption gives special attention to the 
enforceability of the exemption's terms by Retirement Investors. When 
Financial Institutions and Advisers breach their obligations under the 
exemption and cause losses to Retirement Investors, it is generally 
critical that the investors have a remedy to redress the injury. The 
existence of enforceable rights and remedies gives Financial 
Institutions and Advisers a powerful incentive to comply with the 
exemption's standards, implement policies and procedures that are more 
than window-dressing, and carefully police conflicts of interest to 
ensure that the conflicts of interest do not taint the advice.
    Thus, in the case of IRAs and non-ERISA plans, the exemption 
requires the Financial Institution to commit to the Impartial Conduct 
Standards in an enforceable contract with Retirement Investor 
customers. The exemption does not similarly require the Financial 
Institution to execute a separate contract with ERISA investors (plan 
participants, beneficiaries, and fiduciaries), but the Financial 
Institution must acknowledge its fiduciary status and that of its 
Advisers, and ERISA investors can directly enforce their rights to 
proper fiduciary conduct under ERISA section 502(a)(2) and (3). In 
addition, the exemption safeguards Retirement Investors' enforcement 
rights by providing that Financial Institutions and Advisers may not 
rely on the exemption if they include contractual provisions 
disclaiming liability for compensatory remedies or waiving or 
qualifying Retirement Investors' right to pursue a class action or 
other representative action in court. However, the exemption does 
permit Financial Institutions to include provisions waiving the right 
to punitive damages or rescission as contract remedies to the extent 
permitted by other applicable laws. In the Department's view, the 
availability of make-whole relief for such claims is sufficient to 
protect Retirement Investors and incentivize compliance with the 
exemption's conditions.
    While the final exemption retains the proposed exemption's core 
protections, the Department has revised the exemption to ease 
implementation in response to commenters' concerns about the 
exemption's workability. Thus, for example, the final exemption 
eliminates the contract requirement altogether in the ERISA context and 
simplifies the mechanics of contract-formation for IRAs and plans not 
covered by Title I of ERISA. For new customers, the final exemption 
provides that the required contract terms may simply be incorporated in 
the Financial Institution's account opening documents and similar 
commonly-used agreements. The exemption additionally permits reliance 
on a negative consent process for existing contract holders. The 
Department recognizes that Retirement Investors may talk to numerous 
Advisors in numerous settings over the course of their relationship 
with a Financial Institution. Accordingly, the exemption also 
simplifies execution of the contract by simply requiring the Financial 
Institution to execute the contract, rather than each of the individual 
Advisers from whom the Retirement Investor receives advice. For similar 
reasons, the exemption does not require execution of the contract at 
the start of Retirement Investors' conversations with Advisers, as long 
as it is entered into prior to or at the same time as the recommended 
transaction.
    As a means of facilitating use of the exemption, the Department 
also reduced compliance burdens by eliminating some of the conditions 
that were not critical to the exemption's protective purposes, and 
expanding the scope of the exemption's coverage (e.g., by covering 
interests in unit investment trusts (UITs) and certificates of deposit 
(CDs)). The Department eliminated the requirement of adherence to other 
state and federal laws relating to advice as unduly expansive and 
duplicative of other laws; dropped a two-quote requirement; and 
eliminated a mark-up and mark-down disclosure requirement. In addition, 
the Department streamlined the disclosure conditions by simplifying the 
obligations. The Department also provided a mechanism for correcting 
good faith violations of the disclosure conditions, so that Financial 
Institutions would not lose the benefit of the exemption as a result of 
such good faith errors and would have an incentive to promptly correct 
them.
    While making these changes to facilitate the implementation of the 
exemption, the Department emphasizes that the exemption is limited 
because of the severity of the conflicts of interest associated with 
principal transactions. When acting as a principal in a transaction 
involving a plan, participant or beneficiary account, or IRA, a 
fiduciary can have difficulty reconciling its duty to avoid conflicts 
of interest with its concern for its own financial interests as the 
Retirement Investor's counterparty. Of primary concern are issues 
involving liquidity, pricing, transparency, and the fiduciary's 
possible incentive to ``dump'' unwanted assets. The scope of this 
exemption balances the Department's significant concerns regarding 
principal transactions with the need to preserve market choice for 
plans, participants and beneficiary accounts, and IRAs.
    The comments on this exemption, the Best Interest Contract 
Exemption, the Regulation, and related exemptions have helped the 
Department improve this exemption, while preserving and enhancing its 
protections. As described above, the Department has revised the 
exemption to facilitate implementation and compliance with the 
exemption, without diluting its core protections, which are critical to 
reducing the harm caused by conflicts of interest in the marketplace 
for advice. The tax-preferred investments covered by the exemption are 
critical to the financial security and physical health of investors. 
After consideration of the comments, the Department remains convinced 
of the importance of the exemption's core protections.
    ERISA and the Code are rightly skeptical of the dangers posed by 
conflicts of interest, and generally prohibit conflicted advice. Before 
granting exemptive relief, the Department has a statutory obligation to 
ensure that the exemption is in the interests of plan and IRA investors 
and protective of their rights. Adherence to the fundamental fiduciary 
norms and basic protective conditions of this exemption helps ensure 
that investment recommendations are not driven by Adviser conflicts, 
but by the Best Interest of the Retirement Investor. The

[[Page 21096]]

conditions of this exemption are carefully calibrated to permit 
principal transaction and riskless principal transactions in certain 
investments, while protecting Retirement Investors' interest in 
receiving sound advice on vitally important investments. Based upon 
these protective conditions, the Department finds that the exemption is 
administratively feasible, in the interests of plans and their 
participants and beneficiaries and IRA owners, and protective of the 
rights of participants and beneficiaries of plans and IRA owners.
    The preamble sections that follow provide a much more detailed 
discussion of the exemption's terms, comments on the exemption, and the 
Department's responses to those comments. After a discussion of the 
exemption's scope and limitations, the preamble discusses the 
conditions of the exemptions.

A. Scope of Relief in the Exemption

    The exemption provides relief for ``Advisers'' and ``Financial 
Institutions'' to enter into ``principal transactions'' and ``riskless 
principal transactions'' in ``principal traded assets'' with plans and 
IRAs. For purposes of the exemption, a principal transaction is a 
transaction in which an Adviser or Financial Institution is purchasing 
from or selling to the plan, participant or beneficiary account, or IRA 
on behalf of the account of the Financial Institution or the account of 
any person directly or indirectly, through one or more intermediaries, 
controlling, controlled by, or under common control with the Financial 
Institution. The term principal transaction does not include a riskless 
principal transaction as defined in the exemption. A riskless principal 
transaction is defined as a transaction in which a Financial 
Institution, after having received an order from a Retirement Investor 
to buy or sell a principal traded asset, purchases or sells the asset 
for the Financial Institution's own account to offset the 
contemporaneous transaction with the Retirement Investor.
    The exemption uses the term ``Retirement Investor'' to describe the 
types of persons who can be investment advice recipients under the 
exemption, and the term ``Affiliate'' to describe people and entities 
with a connection to the Adviser or Financial Institution. These terms 
are defined in Section VI of this exemption. The following sections 
discuss the scope and conditions of the exemption as well as key 
definitional terms.
1. Principal Traded Assets
    The exemption provides relief for principal transactions and 
riskless principal transactions involving certain investments, referred 
to as ``principal traded assets,'' between a plan, participant or 
beneficiary account, or IRA, and an Adviser, Financial Institution or 
an entity in a control relationship with the Financial Institution, 
when the transaction is a result of an Adviser's or Financial 
Institution's provision of investment advice. Relief is provided from 
ERISA sections 406(a)(1)(A) and (D), and 406(b)(1) and (2), and the 
taxes imposed by Code section 4975(a) and (b), by reason of Code 
section 4975(c)(1)(A), (D) and (E). Relief has not been provided in 
this exemption from ERISA section 406(b)(3) and Code section 
4975(c)(1)(F), which prohibit a fiduciary from receiving any 
consideration for its own personal account from any party dealing with 
the plan or IRA in connection with a transaction involving the assets 
of the plan or IRA.
    The principal traded assets that are permitted to be purchased by 
plans, participant and beneficiary accounts, and IRAs, under the 
exemption include CDs, interests in UITs, and securities within the 
exemption's definition of ``debt security.'' Debt securities are 
generally defined as corporate debt securities offered pursuant to a 
registration statement under the Securities Act of 1933; treasury 
securities; agency securities; and asset-backed securities that are 
guaranteed by an agency or government sponsored enterprise (GSE).
    In addition, the final exemption includes a feature under which the 
definition of principal traded asset can be expanded without amending 
the class exemption. Under the definition of principal traded asset, 
investments can be added to the class exemption in the future based on 
an individual exemption granted by the Department. Accordingly, a 
principal traded asset for purposes of the class exemption also 
includes an investment that is permitted to be purchased under an 
individual exemption granted by the Department after the issuance date 
of this exemption, that provides relief for investment advice 
fiduciaries to engage in the purchase of the investment in a principal 
transaction or riskless principal transaction with a plan or IRA under 
the same conditions as this exemption. To the extent parties wish to 
expand the definition of principal traded asset in the future, they can 
submit a request for an individual exemption to the Department setting 
forth the specific attributes of the principal traded asset, the sales 
and compensation practices, and how conflicts of interest will be 
mitigated with respect to principal transactions and riskless principal 
transactions in that principal traded asset. If the exemption is 
granted, the class exemption will expand to include that investment 
within the definition of principal traded asset.
    The exemption's definition of principal traded assets is more 
expansive with respect to the sale of principal traded assets by plans 
and IRAs. The definition extends to ``securities or other investment 
property,'' which corresponds to the broad range of assets that can be 
recommended by fiduciary advisers under the Regulation. This permits 
trades that may be necessary, according to commenters, when a 
Retirement Investor seeks to sell an investment and cannot obtain a 
reasonable price from a third party. In addition, in response to 
commenters, the Department expanded the scope of the Best Interest 
Contract Exemption to cover riskless principal transactions involving 
all investment products.
    As proposed, the exemption limited the types of assets that could 
be traded (both bought and sold) on a principal basis to corporate debt 
securities offered pursuant to a registration statement under the 
Securities Act of 1933, treasury securities, and agency securities. The 
Department received many comments regarding this limitation and the 
general intent of the exemption. Supporting comments emphasized that 
the exemption's limited scope and conditions were appropriate for the 
mitigation of conflicts of interest and the protection of plans and 
IRAs. One commenter particularly supported the exemption's approach of 
granting relief only to those securities least likely to be subject to 
principal trading abuses. The commenter supported, in particular, the 
exclusion of municipal securities.
    Others urged the Department to broaden the scope of the exemption. 
Many of these commenters argued that principal transactions are 
necessary for the maintenance of inventory, liquidity, access to 
investments, and best execution. They contended that the failure to 
provide broader relief would drive up the cost to investors, and hinder 
normal transactions that are generally classified as facilitation 
trades or riskless principal transactions. Commenters took the position 
that the Department should not substitute its judgment for the judgment 
of investors and advisers. In particular, commenters

[[Page 21097]]

urged the Department to: (a) Provide relief for riskless principal 
transactions, (b) add specific additional securities to the scope of 
the exemption, and (c) provide broad principal transaction relief for 
all securities and other property.
a. Riskless Principal Transactions
    A number of comments noted that the proposal did not specifically 
address riskless principal transactions. In a riskless principal 
transaction, according to a commenter, a Financial Institution, after 
receiving an order to purchase or sell a security from a customer, 
purchases or sells the investment for its own account to offset the 
contemporaneous transaction with the customer. Commenters argued that 
riskless principal transactions are the functional equivalent of agency 
transactions. A commenter asserted that for this reason, riskless 
principal transactions would not involve the incentive to dump unwanted 
investments on Retirement Investors, which was one of the Department's 
concerns. Another commenter indicated that without wider availability 
of riskless principal transactions, many investments would not be 
available at all to plans and IRAs because it is typical for broker-
dealers to engage in transactions with third parties on a riskless 
principal basis rather than a pure agency basis. One commenter stated 
that this is because counterparties may not want to assume settlement 
risk with an investor.
    After consideration of these comments, the Department concurs with 
commenters that broader relief in this area is appropriate. The 
Department intended that the proposal cover riskless principal 
transactions within the general meaning of principal transactions, but 
the transactions would have been limited to the debt securities covered 
under the proposed exemption. The Department agrees with commenters 
that, to the extent a Financial Institution engages in a transaction 
based on an existing customer order, the riskless principal transaction 
can be viewed as functionally similar to an agency transaction, and the 
Department accepts the position of commenters that some investments may 
not be functionally available without this relief. For this reason, the 
Department expanded the scope of the companion Best Interest Contract 
Exemption to permit riskless principal transactions in all investments, 
and provide relief for compensation received in connection with such 
transactions, subject to the conditions of that exemption.
    The Department also clarified that this exemption is available for 
riskless principal transactions involving principal traded assets. The 
definition of a principal transaction now explicitly excludes riskless 
principal transactions, and the exemption's scope specifically 
encompasses both principal transactions and separately-defined riskless 
principal transactions. In this manner, the exemption now clearly draws 
a distinction between principal transactions and riskless principal 
transactions and provides relief for both with respect to principal 
traded assets.
    This approach results in some overlap between coverage of riskless 
principal transactions in the Best Interest Contract Exemption and this 
exemption. With respect to a recommended purchase of an investment that 
occurs in a riskless principal transaction, this exemption is available 
for principal traded assets. The Best Interest Contract Exemption, 
however, provides broader relief for all recommended purchases. In 
addition, sales from a plan or IRA in riskless principal transactions 
can occur under either exemption.
    This approach is intended to provide flexibility to Financial 
Institutions relying on the exemptions. The Department believes that 
some Financial Institutions have business models that involve only 
riskless principal transactions. These Financial Institutions may not, 
as a general matter, hold investments in inventory to sell in principal 
transactions, but they may execute certain transactions as riskless 
principal transactions. Financial Institutions that do not engage in 
principal transactions, as defined in the exemptions, do not have to 
rely on this exemption at all, and can organize their practices to 
comply with the Best Interest Contract Exemption alone.
    On the other hand, Financial Institutions that engage in both 
principal transactions and riskless principal transactions may want to 
organize their practices to comply with this exemption. They may not be 
certain at the outset whether a particular purchase by a plan or IRA 
will be executed as a principal transaction or a riskless principal 
transaction. Those Financial Institutions can rely on this exemption 
for principal traded assets that may be sold to plans and IRAs without 
concern for whether the transaction is, in fact a riskless principal 
transaction or principal transaction.
b. Adding to the Definition of Principal Traded Assets
    Some commenters requested that this exemption extend to principal 
transactions in specific additional types of securities or investments, 
including municipal securities, currency, agency debt securities, CDs 
(including brokered CDs), asset backed securities, unit investment 
trusts (UITs), equities (including new issue and initial public 
offerings), new issue of debt securities, preferred securities, foreign 
corporate securities, foreign sovereign debt, debt of a charitable 
organization, derivatives, bank note offerings and wrap or other 
contracts that are not insurance products.
    In response, the Department added to this final exemption CDs, 
UITs, and asset backed securities guaranteed by an agency or GSE. Both 
CDs and UITs were included as investments permitted to be sold under 
the proposed Best Interest Contract Exemption, and commenters informed 
us that these investments are typically sold in principal transactions. 
Without relief for CDs and UITs in this exemption, commenters asserted 
that Retirement Investors might lose access to such investments. 
Commenters indicated that these investments were common investments in 
ERISA plans, IRAs and non-ERISA plans. The Department therefore 
included them in this final exemption. As with the exemptive relief 
originally proposed regarding principal transactions in debt 
securities, the Department believes that the conflicts of interest 
created by principal transactions in CDs and UITs are effectively 
addressed by the conditions of this exemption so as to protect the 
interests of Retirement Investors while maintaining Retirement 
Investors' access to these investments.
    Agency and GSE guaranteed asset backed securities were always 
intended to be included in the definition of debt security. The 
proposal provided that agency debt securities were defined by reference 
to the Financial Industry Regulatory Authority (FINRA) rule 
6710(l).\16\ Commenters informed us that the Department's definition 
omitted agency and GSE mortgage backed securities. Based on the 
Department's original intent to provide relief for these investments, 
and the view that the conditions are protective in these contexts, the 
Department included them in the final exemption.
---------------------------------------------------------------------------

    \16\ FINRA is registered with the Securities and Exchange 
Commission (SEC) as a national securities association and is a self-
regulatory organization, as those terms are defined in the Exchange 
Act, which operates under SEC oversight.
---------------------------------------------------------------------------

    Reflecting this expansion of relief to CDs, UITs and agency and GSE 
guaranteed asset backed securities, the final exemption uses the term 
``principal traded asset,'' rather than ``debt security'' to describe 
the

[[Page 21098]]

investments that can be purchased or sold.
    As explained in greater detail below, the Department did not expand 
the purchase provisions of the exemption, as some commenters suggested, 
to include other investments such as municipal securities, currency, 
asset backed securities, equities (including new issue and initial 
public offerings), new issue of debt securities, preferred securities, 
foreign corporate securities, foreign sovereign debt, debt of a 
charitable organization, derivatives, bank note offerings and wrap or 
other contracts that are not insurance products. The Department 
determined that the conditions of this exemption may not be 
appropriately tailored to these types of investments. The Department 
invites interested parties to request an individual exemption for other 
investments that they would like to see included in this class 
exemption. This will provide the Department with the opportunity to 
gain additional information about those investments, their sales 
practices and associated conflicts of interest.
c. Principal Transaction Relief for All Securities and Other Property
    Other commenters sought to more generally expand the scope of the 
exemption. Some commenters felt that unrestricted relief should be 
provided with respect to all principal transactions with few, if any, 
conditions. Some of these commenters took issue with the Department's 
decision to place any limitations at all on investments that can be 
purchased or sold in a principal transaction. The commenters expressed 
the view that the Department was substituting its judgment for those of 
individual investors and their advisers.
    In support of their approach, a few commenters urged the Department 
to more closely hew to the approach taken under the securities laws, 
citing Temporary Rule 206(3)-3T issued by the Securities and Exchange 
Commission (SEC) under the Investment Advisers Act of 1940.\17\ 
According to the commenters, Temporary Rule 206(3)-3T applies to 
institutions that are dually registered as investment advisers and 
broker-dealers and to transactions in non-discretionary accounts at 
such institutions, and it permits principal transactions involving all 
securities unless the investment adviser or Affiliate is the issuer of, 
or, at the time of the sale, an underwriter of, a security that is not 
an investment grade debt security. The rule generally requires written 
prospective consent by the customer to principal transactions; oral or 
written pre-transaction disclosure and customer consent; written 
confirmation to the customer; and written annual disclosure to the 
customer of transactions entered into in reliance on the rule.
---------------------------------------------------------------------------

    \17\ 17 CFR 275.206(3)-3T.
---------------------------------------------------------------------------

    Commenters also focused on principal transactions involving sales 
by plans and IRAs. Commenters indicated that broader relief was 
necessary to provide liquidity for Retirement Investors. They said that 
Financial Institutions serve an essential function in purchasing 
securities from their clients who need such liquidity.
    The Department did not accept the commenters' call for relief for 
all principal transactions. The Department's approach in the proposal 
of this exemption was intentionally narrow, based on the potentially 
acute conflicts of interest associated with principal transactions that 
are recommended by fiduciaries. The Department believes that broad 
relief for all principal transactions, without tailored conditions, is 
inconsistent with longstanding principles that fiduciaries must act 
with loyalty to Retirement Investors. Because the fiduciary is on both 
sides of a principal transaction, the fiduciary duty of loyalty is 
sorely tested. In addition, the securities typically traded in 
principal transactions often lack objective market prices and 
Retirement Investors may have difficulty evaluating the fairness of a 
particular transaction. Principal traded investments also can be 
associated with low liquidity, low transparency and the possible 
incentive to dump unwanted investments.
    Therefore, although the Department's approach harmonizes in many 
ways, as discussed below, with the disclosures required by the SEC's 
Temporary Rule 206(3)-3T, the Department did not adopt an exemption 
that is as broad in scope. The Department also notes in this respect 
that the SEC has not yet finalized its approach to rule 206(3)-3T, and 
the SEC has indicated the delay is related to the SEC's consideration 
of regulatory standards of care for broker-dealers and investment 
advisers under section 913 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act). In the most recent release 
proposing to extend the Temporary Rule, the SEC stated:

    As part of our broader consideration of the regulatory 
requirements applicable to broker-dealers and investment advisers, 
we intend to carefully consider principal trading by advisers, 
including whether rule 206(3)-3T should be substantively modified, 
supplanted, or permitted to sunset.\18\
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    \18\ See SEC's Release No. IA-3893, August 12, 2014.

Given the SEC's ongoing consideration of these issues, the Department 
does not believe there is a significant advantage to mirroring the 
scope of the Temporary Rule.
    Although the Department retained the limited definition of 
principal traded asset, as discussed above, for recommendations that a 
plan or IRA purchase an investment, the Department did provide broader 
relief for recommended sales from a plan or IRA to a Financial 
Institution. The Department is persuaded by commenters that a broader 
exemption is necessary to provide liquidity to plans and IRAs.
    The Department also notes that the final Regulation provides 
additional ways in which parties can engage in principal transactions 
and riskless principal transactions and avoid prohibited transactions. 
The Regulation provides that a person is not a fiduciary when the 
person engages in an arm's length transaction with an independent plan 
fiduciary with financial expertise, as defined in the Regulation. 
Financial professionals that engage in such transactions are not 
considered fiduciaries, and may rely on other exemptions such as PTE 
75-1, Part II, or ERISA section 408(b)(17) and Code section 
4975(d)(20), for a broader range of principal transactions and riskless 
principal transactions. Therefore, the concerns of commenters such as 
the Stable Value Investment Association, about principal transactions 
involving a stable value fund managed by a professional investment 
manager, should be addressed in that fashion.
    Finally, this exemption does not affect the ability of a self-
directed investor to obtain the services of a financial professional to 
effect or execute a transaction involving any type of investment, in 
the absence of investment advice. In that sense, the Department is not 
limiting investment opportunities for individual investors or 
substituting the Department's judgment for theirs. Instead, the 
exemption is aimed squarely at conflicted investment advice by 
fiduciaries and is intended to minimize the harms of such conflicts of 
interest.
    In this regard, one commenter requested a clarification as to 
whether an exemption is necessary for the provision of principal 
transaction services where the services do not involve the provision of 
individual recommendations to a plan or IRA. In

[[Page 21099]]

response, the Department notes that relief from ERISA section 406(b) 
would only be necessary to the extent the service provider was acting 
as a fiduciary. To the extent the service provider does not make 
recommendations, it does not act as a fiduciary investment adviser. If 
the service provider is not a fiduciary, ERISA section 406(b) relief is 
not necessary, and the other exemptions referenced above, apply.
2. Exclusions
    The exclusions set forth in Section I(c) of the proposal remain a 
part of the final exemption. First, under Section I(c)(1), Advisers who 
have or exercise discretionary authority or discretionary control with 
respect to management of the assets of a plan, participant or 
beneficiary account, or IRA or who exercise any discretionary authority 
or control respecting management or the disposition of the assets, or 
have any discretionary authority or discretionary responsibility in the 
administration of the plan, participant or beneficiary account, or IRA, 
may not take advantage of relief under the exemption to engage in 
principal transactions and riskless principal transactions with such 
investors.
    A comment related to this provision asked that the limitation on 
investment managers be modified so that Financial Institutions that 
sponsor separately managed accounts that use independent, individual 
investment managers should be permitted to engage in principal 
transactions on behalf of their managed plans and IRAs with the 
sponsor. The Department did not adopt this suggestion. Instead, the 
Department notes that the Regulation was revised to provide that a 
person does not act as a fiduciary when engaged in an arm's length 
transaction with a plan fiduciary with financial expertise under the 
circumstances set forth in the Regulation. In such circumstances, the 
financial professionals may, therefore, rely on existing exemptions for 
non-fiduciary principal transactions and riskless principal 
transactions.
    Second, under Section I(c)(2), the exemption is not available for a 
principal transaction involving a plan covered by Title I of ERISA if 
the Adviser or Financial Institution, or any Affiliate is the employer 
of employees covered by the plan. In accordance with this condition, 
the exemption is not available for a principal transaction entered into 
as part of a rollover from such a plan to an IRA, where the principal 
transaction is being executed by the plan, not the IRA. This 
restriction on employers does not apply in the case of an IRA or other 
similar plan that is not covered by Title I of ERISA. Accordingly, an 
Adviser or Financial Institution may provide advice to the beneficial 
owner of an IRA who is employed by the Adviser, its Financial 
Institution or an Affiliate, and receive compensation as a result, 
provided the IRA is not covered by Title I of ERISA.
    No comments were received specific to the principal transactions 
exemption on proposed Section I(c)(2). Comments were received, however, 
on the same language, proposed in Section I(c)(1), of the Best Interest 
Contract Exemption. Specifically, industry commenters requested 
elimination of this exclusion in the Best Interest Contract Exemption. 
In particular, they said that Financial Institutions in the business of 
providing investment advice should not be compelled to hire a 
competitor to provide services to the Financial Institution's own plan. 
They warned that the exclusion could effectively prevent these 
Financial Institutions from providing any investment advice to their 
employees. Some commenters additionally stated that for compliance 
reasons, employees of a Financial Institution are often required to 
maintain their financial assets with that Financial Institution. As a 
result, they argued employees of Financial Institutions could be denied 
access to investment advice on their retirement savings.
    As with the Best Interest Contract Exemption, the Department has 
not scaled back the exclusion. As noted above, the Department did not 
receive comments requesting that Financial Institutions be able to 
engage in principal transactions with their in-house plans. More 
generally, however, the Department continues to be concerned that the 
danger of abuse is compounded when the advice recipient receives 
recommendations from the employer, upon whom he or she depends for a 
job, to make investments in which the employer has a financial 
interest. To protect employees from abuse, employers generally should 
not be in a position to use their employees' retirement benefits as 
potential revenue or profit sources, without stringent safeguards. See, 
e.g., ERISA section 403(c)(1) (generally providing that ``the assets of 
a plan shall never inure to the benefit of any employer''). 
Additionally, the exclusion of employers in Section I(c) does not apply 
in the case of an IRA or other similar plan that is not covered by 
Title I of ERISA. The decision to open an IRA account or obtain IRA 
services from the employer is much more likely to be entirely voluntary 
on the employees' part than would be true of their interactions with 
the retirement plan sponsored and designed by their employer for its 
employee benefit program. Accordingly, an Adviser or Financial 
Institution may provide advice to the beneficial owner of an IRA who is 
employed by the Adviser, its Financial Institution or an Affiliate 
regarding a principal transaction or riskless principal transaction, 
and engage in a principal transaction or riskless principal transaction 
as a result, provided the IRA is not covered by Title I of ERISA, and 
the conditions of this exemption are satisfied.
    Section I(c)(2) further provides that the exemption is unavailable 
if the Adviser or Financial Institution is a named fiduciary or plan 
administrator, as defined in ERISA section 3(16)(A) with respect to an 
ERISA plan, or an Affiliate thereof, that was selected to provide 
advice to the plan by a fiduciary who is not independent of them. This 
provision is intended to disallow the selection of Advisers and 
Financial Institutions by named fiduciaries or plan administrators that 
have a significant financial stake in the selection and was adopted in 
the final exemption unchanged from the proposal.\19\
---------------------------------------------------------------------------

    \19\ The definition of ``independent'' was adjusted in response 
to comments, as discussed below, to permit circumstances in which 
the person selecting the Adviser and Financial Institution could 
receive no more than 2% of its compensation from the Financial 
Institution.
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B. Conditions of the Exemption

    Section I, discussed above, establishes the scope of relief 
provided by this Principal Transactions Exemption. Sections II-V set 
forth the conditions of the exemption. All applicable conditions must 
be satisfied in order to avoid application of the specified prohibited 
transaction provisions of ERISA and the Code. The Department finds 
that, subject to these conditions, the exemption is administratively 
feasible, in the interests of plans and of their participants and 
beneficiaries, and IRA owners and protective of the rights of the 
participants and beneficiaries of such plans and IRA owners. Under 
ERISA section 408(a), and Code section 4975(c)(2), the Secretary may 
not grant an exemption without making such findings. The conditions of 
the exemption, comments on those conditions, and the Department's 
responses, are described below.
1. Enforceable Right to Best Interest Advice (Section II)
    Section II of the exemption sets forth the requirements that 
establish the Retirement Investor's enforceable right

[[Page 21100]]

to adherence to the Impartial Conduct Standards and related conditions. 
For advice to certain Retirement Investors--specifically, advice 
regarding transactions with IRAs, and plans that are not covered by 
Title I of ERISA (non-ERISA plans), such as Keogh plans--Section II(a) 
requires the Financial Institution and Retirement Investor to enter 
into a written contract that includes the provisions described in 
Section II(b)-(d) of the exemption and that also does not include any 
of the ineligible provisions described in Section II(f) of the 
exemption, and provide the disclosures set forth in Section II(e). As 
discussed further below, pursuant to Section II(g) of the exemption, 
advice to Retirement Investors regarding ERISA plans does not have to 
be subject to a written contract but Advisers and Financial 
Institutions must comply with the substantive standards established in 
Section II(b)-(e) to avoid liability for a non-exempt prohibited 
transaction.
    The contract with Retirement Investors regarding IRAs and non-ERISA 
plans must include the Financial Institution's acknowledgment of its 
fiduciary status and that of its Advisers, as required by Section 
II(b); the Financial Institution's agreement that it and its Advisers 
will adhere to the Impartial Conduct Standards, including a Best 
Interest standard, as required by Section II(c); the Financial 
Institution's warranty that it has adopted and will comply with certain 
policies and procedures, including anti-conflict policies and 
procedures reasonably and prudently designed to ensure that Advisers 
adhere to the Impartial Conduct Standards, as required by Section 
II(d). The Financial Institution's disclosure of information about 
Material Conflicts of Interest associated with principal transactions 
and riskless principal transactions, as required by Section II(e), may 
be provided in the contract or in a separate single written disclosure. 
Section II(f) generally provides that the exemption is unavailable if 
the contract includes exculpatory provisions or provisions waiving the 
rights and remedies of the plan, IRA or Retirement Investor, including 
their right to participate in a class action in court. The contract 
may, however, provide for binding arbitration of individual claims, and 
may waive contractual rights to punitive damages or rescission.
    The contract between the IRA or non-ERISA plan, and the Financial 
Institution, forms the basis of the IRA's or non-ERISA plan's 
enforcement rights. The Department intends that all the contractual 
obligations imposed on the Financial Institution (the Impartial Conduct 
Standards and warranties) will be actionable by the IRAs and non-ERISA 
plans. Because these standards are contractually imposed, an IRA or 
non-ERISA plan has a contract claim if, for example, its Adviser 
recommends an investment product that is not in the Best Interest of 
the IRA or other non-ERISA plan.
    In the Department's view, these contractual rights serve a critical 
function for IRA owners and participants and beneficiaries of non-ERISA 
plans. Unlike participants and beneficiaries in plans covered by Title 
I of ERISA, IRA owners and participants and beneficiaries in non-ERISA 
plans do not have an independent statutory right to bring suit against 
fiduciaries for violation of the prohibited transaction rules. Nor can 
the Secretary of Labor bring suit to enforce the prohibited 
transactions rules on their behalf.\20\ Thus, for investors in IRAs and 
non-ERISA plans, the contractual requirement creates a mechanism for 
investors to enforce their rights and ensures that they will have a 
remedy for misconduct. In this way, the exemption creates a powerful 
incentive for Financial Institutions and Advisers alike to oversee and 
adhere to basic fiduciary standards when engaging in principal 
transactions and riskless principal transactions, without requiring the 
imposition of unduly rigid and prescriptive rules and conditions.
---------------------------------------------------------------------------

    \20\ An excise tax does apply in the case of a violation of the 
prohibited transaction provisions of the Code, generally equal to 
15% of the amount involved. The excise tax is generally self-
enforced; requiring parties not only to realize that they've engaged 
in a prohibited transaction but also to report it and pay the tax. 
Parties who have participated in a prohibited transaction for which 
an exemption is not available must pay the excise tax and file Form 
5330 with the Internal Revenue Service.
---------------------------------------------------------------------------

    Under Section II(g), however, the written contract requirement does 
not apply to advice to Retirement Investors regarding transactions with 
plans that are covered by Title I of ERISA (ERISA plans) in light of 
the existing statutory framework which provides a pre-existing 
enforcement mechanism for these investors and the Department. Instead, 
Advisers and Financial Institutions must satisfy the provisions in 
Section II(b)-(e) as conditions of the exemption when transacting with 
such Retirement Investors. Under the terms of the exemptions, the 
Financial Institution must provide a written acknowledgment of its and 
its Advisers' fiduciary status prior to or at the same time as the 
execution of the transaction, although it does not have to be part of a 
contract, as required by Section II(b); the Financial Institution and 
its Advisers must comply with the Impartial Conduct Standards, as 
required by Section II(c); the Financial Institutions must establish 
and comply with certain policies and procedures, as required by Section 
II(d); and they must provide the disclosures required by Section II(e).
    If these conditions are not satisfied with respect to an ERISA plan 
engaging in a principal transaction or a riskless principal 
transaction, the Adviser and Financial Institution would be unable to 
rely on the exemption for relief from ERISA's prohibited transactions 
restrictions. An Adviser's failure to comply with the exemption would 
result in a non-exempt prohibited transaction under ERISA section 406 
and would likely constitute a fiduciary breach under ERISA section 404. 
As a result, a plan, plan participant or beneficiary would be able to 
sue under ERISA section 502(a)(2) or (3) to recover any loss in value 
to the plan (including the loss in value to an individual account), or 
to obtain disgorgement of any wrongful profits or unjust enrichment. In 
addition, the Secretary of Labor can enforce ERISA's prohibited 
transaction and fiduciary duty provisions with respect to these ERISA 
plans, and an excise tax under the Code, as described above, applies.
    In this regard, under Section II(g)(5) of the exemption, the 
Financial Institution and Adviser may not rely on the exemption if, in 
any contract, instrument, or communication they disclaim any 
responsibility or liability for any responsibility, obligation, or duty 
under Title I of ERISA to the extent the disclaimer would be prohibited 
by ERISA section 410, waive or qualify the right of the Retirement 
Investor to bring or participate in a class action or other 
representative action in court in a dispute with the Adviser or 
Financial Institution, or require arbitration or mediation of 
individual claims in locations that are distant or that otherwise 
unreasonably limit the ability of the Retirement Investors to assert 
the claims safeguarded by this exemption. The exemption's 
enforceability, and the potential for liability, is critical to 
ensuring adherence to the exemption's stringent standards and 
protections, notwithstanding the competing pull of the conflicts of 
interest associated with principal transactions and riskless principal 
transactions.
    The Department expects claims of Retirement Investors regarding 
investments in ERISA plans to be brought under ERISA's enforcement 
provisions, discussed above. In general, ERISA section 410 invalidates

[[Page 21101]]

instruments purporting to relieve a fiduciary from responsibility or 
liability for any responsibility, obligation, or duty under ERISA. 
Accordingly, provisions purporting to waive fiduciary obligations under 
ERISA serve only to mislead Retirement Investors about the scope of 
their rights. Additionally, the legislative intent of ERISA was, in 
part, to provide for ``ready access to federal courts.'' Accordingly, 
any recommended transaction covered by a contract or other instrument 
that waives or qualifies the right of the Retirement Investor to bring 
or participate in a class action or other representative action in 
court, will not be eligible for relief under this exemption.
    A number of comments were received on the contract requirement as 
it was proposed. The comments, and the Department's responses, are 
discussed below. The Department notes that some of the commenters 
simply cross-referenced their comments, in the entirety, with respect 
to the same provisions in the proposed Best Interest Contract 
Exemption. Additionally, some commenters focused their comments solely 
on the Best Interest Contract Exemption. The Department determined it 
was important that the contract provisions in the Best Interest 
Contract Exemption be compatible with the contract provisions in this 
exemption, so that the two exemptions can easily be used together. For 
this reason, the Department considered all comments made on either 
exemption on a consolidated basis, and made corresponding changes in 
the two exemptions. For ease of use, the Department has included in 
this preamble the same general discussion of comments as in the Best 
Interest Contract Exemption, despite the fact that some comments 
discussed below were not made directly with respect to this exemption.
    In this regard, one commenter inquired as to whether the contract 
required in this exemption could be combined with the contract required 
by the Best Interest Contract Exemption, or whether two contracts would 
be needed. It was the Department's intent in crafting this exemption 
that it could be used in connection with the Best Interest Contract 
Exemption, and it is the Department's view that there need only be one 
contract. If parties wish to give themselves flexibility to engage in 
principal transactions and riskless principal transactions with 
Retirement Investors, they can include the contract provisions that are 
specific to principal transactions and riskless principal transactions 
and obtain the Retirement Investor's consent to participate in such 
transactions.
a. Contract Requirement Applicable to IRAs and Non-ERISA Plans
    A number of commenters took the position that the consumer 
protections afforded by the contract requirement are an essential 
feature of the exemption, particularly in the IRA market. Commenters 
indicated that enforceability is critical in the IRA market because of 
IRA owners' lack of a statutory right to enforce prohibited 
transactions provisions. Commenters said that, in order to achieve the 
goal of providing meaningful new protections to Retirement Investors, 
the exemption must provide a mechanism by which Advisers and Financial 
Institutions can be held legally accountable for the retirement 
recommendations they make.
    Many other commenters, however, raised significant objections to 
the contract requirement. Commenters pointed to certain conditions of 
the exemption that they found ambiguous or subjective and indicated 
that these conditions could form the basis of class action lawsuits by 
disappointed investors. Some commenters said the contract requirement 
and associated litigation exposure will cause investment advice 
providers to cease serving Retirement Investors or provide only fee-
based accounts that do not vary on the basis of the advice provided, 
resulting in the loss of services to retirement investors with smaller 
account balances. These commenters stated that investment advice 
fiduciaries would not risk the anticipated legal liability for 
Retirement Investors, or at least with respect to small accounts. 
Commenters also indicated that the SEC's Temporary Rule 206(3)-3T 
already addresses the issues regarding principal transactions that the 
Department is attempting to address.
    In the final exemption, the Department retained the contract 
requirement with respect to IRAs and non-ERISA plans. The contractual 
commitment provides an administrable means of ensuring fiduciary 
conduct, eliminating ambiguity about the fiduciary nature of the 
relationship, and enforcing the exemption's conditions, thereby 
assuring compliance. The existence of enforceable rights and remedies 
gives Financial Institutions and Advisers a powerful incentive to 
comply with the exemption's standards, implement effective anti-
conflict policies and procedures, and carefully police conflicts of 
interest. The enforceable contract gives clarity to the fiduciary 
nature of the undertaking, and ensures that Advisers and Financial 
Institutions do not subordinate the interests of the Retirement 
Investor to their own competing financial interests. The contract 
effectively aligns the interests of Retirement Investor, Advisers, and 
the Financial Institution, and gives the Retirement Investor the means 
to redress injury when violations occur.
    Without a contract, the possible imposition of an excise tax 
provides an additional, but inadequate incentive to ensure compliance 
with the exemption's standards-based approach. This is particularly 
true because imposition of the excise tax critically depends on 
fiduciaries' self-reporting of violations, rather than independent 
investigations and litigation by the IRS. In contrast, contract 
enforcement does not rely on conflicted fiduciaries' assessment of 
their own adherence to fiduciary norms or require the creation and 
expansion of a government enforcement apparatus. The contract provides 
an administrable way of ensuring adherence to fiduciary standards, 
broadly applicable to an enormous range of investments and advice 
relationships.
    The enforceability of the exemption's provisions enables the 
Department to grant exemptive relief based upon broad protective 
standards rather than rely exclusively upon highly proscriptive 
conditions. In the context of this exemption, the risk of litigation 
and enforcement serves many of the same functions that it has for 
hundreds of years under the law of trust and agency. It gives 
fiduciaries a powerful incentive to adhere to broad, flexible, and 
protective standards applicable to principal transactions and riskless 
principal transactions by imposing liability and providing a remedy 
when fiduciaries fail to comply with those standards.
    In addition, a number of features of this final exemption, 
discussed more fully below, should temper commenters' concerns about 
the risk of excessive litigation. In particular, the exemption permits 
Advisers and Financial Institutions to require mandatory arbitration of 
individual claims, so that claims that do not involve systemic abuse or 
entire classes of participants can be resolved outside of court. 
Similarly, the exemption permits waivers of the right to obtain 
punitive damages or rescission based on violation of the contract. In 
the Department's view, make-whole compensatory relief is sufficient to 
incentivize compliance and redress injury caused by fiduciary 
misconduct. The Department has also clarified a number of the 
exemption's conditions and simplified the disclosure and

[[Page 21102]]

compliance obligations to facilitate adherence to the exemption's 
terms.
    The core principles of the exemption are well-established under 
trust law, ERISA and the Code, and have a long history of 
interpretations in court. Moreover, the Impartial Conduct Standards are 
measured based on the circumstances existing at the time of the 
recommendation, not based on the ultimate performance of the investment 
with the benefit of hindsight. It is well settled as a legal matter 
that fiduciary advisers are not guarantors of the success of 
investments under ERISA or the Code, and this exemption does nothing to 
change that fact. Finally, the Department added provisions enabling 
Advisers and Financial Institutions to correct good faith errors in 
disclosure, without facing loss of the exemption.
    The Department did not rely solely on the approach in the SEC's 
Temporary Rule 206(3)-3T, or another primarily disclosure-based 
approach, as suggested by some commenters. In the Department's view, 
disclosure of conflicts is a necessary, but not sufficient, basis for 
relief in the context of fiduciary self-dealing involving tax-favored 
accounts.
    One commenter asked the Department to address the interaction of 
the contract cause of action and state securities laws. In this 
connection, the Department confirms that it is not the Department's 
intent to preempt or supersede state securities law and enforcement, 
and the state securities laws remain subject to the ERISA section 
514(b)(2)(A) savings clause.
b. No Contract Requirement Applicable to ERISA Plans
    Under Section II(g) of the exemption, there is no contract 
requirement for transactions involving ERISA plans, but Financial 
Institutions and their Advisers must satisfy the conditions of Section 
II(b)-(e), including the conditions requiring written fiduciary 
acknowledgment, adherence to Impartial Conduct Standards, policies and 
procedures, and disclosures.
    The Department eliminated the proposed contract requirement with 
respect to ERISA plans in this final exemption in response to public 
comment on this issue. A number of commenters indicated that the 
contract requirement was unnecessary for ERISA plans due to the 
statutory framework that already provides enforcement rights to such 
plans, their participants and beneficiaries, and the Secretary of 
Labor. Some commenters additionally questioned the extent to which the 
contract provided additional rights or remedies, and whether state-law 
contract claims would be pre-empted under ERISA's pre-emption 
provisions.
    In the Department's view, the requirement that a Financial 
Institution provide written acknowledgement of fiduciary status for 
itself and its Advisers provides protections in the ERISA plan context 
that are comparable to the contract requirement for IRAs and non-ERISA 
plans. As a result of the written acknowledgment of fiduciary status, 
the fiduciary nature of the relationship will be clear to the parties 
both at the time of the investment transaction, and in the event of 
subsequent disputes over the conduct of the Advisers or Financial 
Institutions. There will be far less cause for the parties to litigate 
disputes over fiduciary status, as opposed to the substance of the 
fiduciaries' recommendations and conduct.
2. Contract Operational Issues--Section II(a)
    Section II(a) specifies the mechanics of entering into the contract 
and provides that the contract must be enforceable against the 
Financial Institution. In addition, the section indicates that the 
contract may be a master contract covering multiple recommendations, 
and that it may cover advice that was rendered prior to the execution 
of the contract as long as the contract is entered into prior to or at 
the same time as the execution of the recommended transaction.
    Section II(a)(1) further describes the methods for obtaining 
customer assent to the contract. For ``new contracts,'' the Retirement 
Investor's assent must be demonstrated through a written or electronic 
signature. The exemption provides flexibility by permitting the 
contract terms to be set forth in a standalone document or in an 
investment advisory agreement, investment program agreement, account 
opening agreement, insurance or annuity contract or application, or 
similar document, or amendment thereto.
    For Retirement Investors with ``existing contracts,'' the exemption 
permits assent to be evidenced either by affirmative consent, as 
described above, or by a negative consent procedure. Under the negative 
consent procedure, the Financial Institution delivers a proposed 
contract amendment along with the disclosure required in Section II(e) 
to the Retirement Investor prior to January 1, 2018, and if the 
Retirement Investor does not terminate the amended contract within 30 
days, the amended contract is effective. If the Retirement Investor 
does terminate the contract within that 30-day period, this exemption 
will provide relief for 14 days after the date on which the termination 
is received by the Financial Institution.\21\ An existing contract is 
defined in the exemption as ``an investment advisory agreement, 
investment program agreement, account opening agreement, insurance 
contract, annuity contract, or similar agreement or contract that was 
executed before January 1, 2018 and remains in effect.'' If the 
Financial Institution elects to use the negative consent procedure, it 
may deliver the proposed amendment by mail or electronically, but it 
may not impose any new contractual obligations, restrictions, or 
liabilities on the Retirement Investor by negative consent.
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    \21\ Alternatively, for purposes of this exemption, Advisers and 
Financial Institutions can provide the contractual terms required by 
the exemption and permit the Retirement Investor to specifically 
decline to authorize principal transactions and riskless principal 
transactions within 30 days but continue the existing contract. Of 
course, to the extent prohibited transaction relief is needed for 
transactions under the existing contract, the Adviser and Financial 
Institution would need to comply with another exemption.
---------------------------------------------------------------------------

    Finally, Section II(a)(2) of the exemption requires the Financial 
Institution to maintain an electronic copy of the Retirement Investor's 
contract on its Web site that is accessible by the Retirement Investor. 
This condition ensures that the Retirement Investor has ready access to 
the terms of the contract, and reinforces the exemption's goals of 
clearly establishing the fiduciary status of the Adviser and Financial 
Institution and ensuring their adherence to the exemption's conditions.
    Comments on specific contract operational issues are discussed 
below.
a. Contract Timing
    As proposed, Section II(a) required that, ``[p]rior to recommending 
that the plan, participant or beneficiary account, or IRA purchase, 
sell or hold the Asset, the Adviser and Financial Institution enter 
into a written contract with the Retirement Investor that incorporates 
the terms required by Section II(b)-(e).'' A large number of commenters 
responded to various aspects of this proposed requirement.
    Many commenters objected to the timing of the contract requirement. 
They said that requiring execution of a contract ``prior to'' any 
recommendations would be contrary to existing industry practices. The 
commenters indicated that preliminary discussions may evolve into 
recommendations before a Retirement Investor has decided to work with a 
particular Adviser and Financial Institution. Requiring a contract 
upfront

[[Page 21103]]

could chill such preliminary discussions, unduly complicate the 
relationship between the Adviser and the Retirement Investor, and 
interfere with an investor's ability to shop around. Many commenters 
suggested that it would be better to time the requirement so that the 
contract would have to be entered into prior to the execution of the 
actual principal transaction, or even later, rather than before any 
advice was rendered. While some other commenters supported the proposed 
timing, noting the benefit of allowing Retirement Investors the chance 
to carefully review the contract prior to engaging in transactions, 
several commenters that strongly supported the contract requirement 
agreed that the timing could be adjusted without loss of protection to 
the Retirement Investor.
    In the Department's view, the precise timing of the contract is not 
critical to the exemption, provided that the parties enter into a 
contract covering the advice. The Department did not intend to chill 
developing advice relationships or limit investors' ability to shop 
around. Therefore, the Department adjusted the exemption on this point 
by deleting the proposed requirement that the contract be entered into 
prior to the advice recommendation. Instead, the exemption generally 
provides that the advice must be subject to an enforceable written 
contract entered into prior to or at the same time as the execution of 
the recommended transaction. However, in order for the exemption to be 
available to recommendations made prior to the contract's formation, 
the contract's terms must cover the prior recommendations.
    A few commenters suggested that the Department require the contract 
to be a separate document, not combined with any other document. 
However, other commenters requested that the Department allow Financial 
Institutions to incorporate the contract terms into other account 
documents. While the Department believes the contract is critical to 
IRA and non-ERISA plan investors, the Department recognizes the need 
for flexibility in its implementation. Therefore, the exemption 
contemplates that the contract may be incorporated into other documents 
to the extent desired by the Financial Institution. Additionally, as 
requested by commenters, the Department confirms that the contract 
requirement may be satisfied through a master contract covering 
multiple recommendations and does not require execution prior to each 
additional recommendation.
b. Contract Parties
    A number of commenters questioned the necessity of the proposed 
requirement that Advisers be parties to the contract. These commenters 
indicated that the proposed requirement posed significant logistical 
challenges. For example, commenters stated that Advisers often work in 
teams and it would be difficult to obtain signatures from all such 
Advisers. Similarly, if call center representatives made 
recommendations that include principal transactions and riskless 
principal transactions, it could be hard to cover them under a 
contract. Over the course of a Retirement Investor's relationship with 
a Financial Institution, he or she could receive advice from a number 
of persons. Requiring that each such person execute a contract could 
prove difficult and unwieldy.
    Based upon these objections, the Department deleted the requirement 
that individual Advisers be parties to the contract. The Financial 
Institution must be a party to the contract and take responsibility for 
satisfying the exemption's conditions, including the obligation to have 
policies and procedures reasonably and prudently designed to ensure 
that individual Advisers adhere to the Impartial Conduct Standards, and 
the obligation to insulate the Adviser from incentives to violate the 
Best Interest standard. Such Advisers include call center 
representatives who provide investment advice within the meaning of the 
Regulation.
    Some commenters suggested that the Department provide additional 
flexibility and allow the individual Adviser to be obligated under the 
contract instead of the Financial Institution. The Department has not 
adopted that suggestion. To ensure operation of the exemption as 
intended, the Financial Institution should be a party to the contract. 
The supervisory responsibility and liability of the Financial 
Institution is important to the exemption's protections. In particular, 
the exemption contemplates that the Financial Institution will adopt 
and monitor stringent anti-conflict policies and procedures; avoid 
financial incentives that undermine the Impartial Conduct standards; 
and take appropriate measures to ensure that it and its representatives 
adhere to the exemption's conditions. The contract provides both a 
mechanism for imposing these obligations on the Financial Institution 
and creates a powerful incentive for the Financial Institution to take 
the obligations seriously in the management and supervision of 
investment recommendations.
c. Contract Signatures
    Section II(a) of the exemption provides that the contract must be 
enforceable against the Financial Institution. As long as that is the 
case, the Financial Institution is not required to sign the contract. 
Section II(a) of the exemption further describes the methods through 
which customer assent may be achieved, and reflects commenters' 
requests for greater specificity on this point.
    With respect to new contracts, a few commenters asked the 
Department to confirm that electronic execution by the Retirement 
Investor is sufficient. Another commenter asked about telephone assent. 
In the final exemption, the Department specifically permits electronic 
execution as a form of customer assent. The Department has not 
permitted telephone assent, however, because of the potential issues of 
proof regarding the existence and terms of a contract executed in that 
manner. It is the Department's goal that Retirement Investors obtain 
clear evidence of the contract terms and their applicability to the 
Retirement Investor's own account or contract. The exemption will best 
serve its purpose if the contractual commitments are clear to all the 
parties, and if ancillary disputes about the fiduciary nature of the 
advice relationship are avoided. For this same reason, the exemption 
requires that a copy of the applicable contract be maintained on a Web 
site accessible to the Retirement Investor.
    Commenters also asked for the ability to use a negative consent 
procedure with respect to existing customers to avoid the expense and 
difficulty associated with obtaining a large number of client 
signatures. The Department adjusted the exemption on this point to 
permit amendment of existing contracts by negative consent, as 
discussed above. As this approach will still result in the Retirement 
Investor receiving clear evidence of the contract terms and their 
applicability to the Retirement Investor's own account or contract, the 
Department concurred with commenters on its use.
    Treating the Retirement Investor's silence as consent after 30 days 
provides the Retirement Investor a reasonable opportunity to review the 
new terms and to reject them. The Financial Institution may not use the 
negative consent procedure, however, to impose new obligations, 
restrictions or liabilities on the Retirement Investor in connection 
with this exemption. Any attempt by the Financial Institution to

[[Page 21104]]

impose additional obligations, restrictions or liabilities on the 
Retirement Investor must receive affirmative consent from the 
Retirement Investor, and cannot violate Section II(f).
    A number of commenters also asked that the exemption authorize 
Financial Institutions to satisfy the contract requirement for all 
Retirement Investors--including new customers after the January 1, 
2018--through unilateral contracts or implied or negative consent. Some 
commenters suggested that the Department should not require a contract 
at all, but only a ``customer bill of rights'' or similar disclosure, 
without any additional signature requirement. Some commenters suggested 
that the requirement of obtaining signatures could delay execution of 
time sensitive investment strategies.
    Although the final exemption accommodates a wide variety of 
concerns regarding contract operational issues, the Department did not 
adopt the alternative approaches suggested by some commenters, such as 
merely requiring delivery of a customer bill of rights, broader 
reliance on a unilateral contract approach, or increased reliance on 
negative consent. The Department intends that Retirement Investors that 
are new customers of the Financial Institution should enter into an 
enforceable contract under Section II(a)(1)(i). Consistent with the 
Department's goal that Retirement Investors obtain clear evidence of 
the contract terms and their applicability to the Retirement Investor's 
own account or contract, the exemption limits the negative consent 
option to existing customers as a form of transitional relief, so that 
Financial Institutions can avoid the burdens associated with obtaining 
signatures from a large number of already-existing customers.
    Apart from this transitional relief, the Department does not 
believe it is appropriate to dispense with the clarity, enforceability 
and legal protections associated with an affirmative contract. 
Contracts are commonplace in a wide range of commercial transactions 
occurring in person, on the web, and elsewhere. The Department has 
facilitated the process by providing that Financial Institutions can 
incorporate the contract terms into commonplace account opening or 
similar documents that they already use; by permitting electronic 
signatures; and by revising the timing rules, so that the contract's 
execution can follow the provision of advice, as long as it precedes or 
occurs at the same time as the execution of the recommended 
transaction.
3. Fiduciary Acknowledgment--Section II(b)
    Section II(b) of the exemption requires the Financial Institution 
to affirmatively state in writing that the Financial Institution and 
the Adviser(s) act as fiduciaries under ERISA or the Code, or both, 
with respect to any investment advice regarding principal transactions 
and riskless principal transactions provided by the Financial 
Institution or the Adviser subject to the contract or, in the case of 
an ERISA plan, with respect to any investment advice regarding the 
principal transactions and riskless principal transactions between the 
Financial Institution and the Plan or participant or beneficiary 
account.
    With respect to IRAs and non-ERISA plans, if this acknowledgment of 
fiduciary status does not appear in a contract with a Retirement 
Investor, the exemption is not satisfied with respect to transactions 
involving that Retirement Investor. With respect to ERISA plans, this 
acknowledgment must be provided to the Retirement Investor prior to or 
at the same time as the execution of the recommended transaction, but 
not as part of a contract. This fiduciary acknowledgment is critical to 
ensuring clarity and certainty with respect to fiduciary status of both 
the Adviser and Financial Institution under ERISA and the Code with 
respect to that advice.
    The fiduciary acknowledgment provision received significant support 
from some commenters. Commenters described it as a necessary protection 
and noted that it would clarify the obligations of the Adviser. One 
commenter said that facilitating proof of fiduciary status should 
enhance investors' ability to obtain a remedy for Adviser misconduct in 
arbitration by eliminating ancillary litigation over fiduciary status. 
Rather than litigate over fiduciary status, the fiduciary 
acknowledgment would help ensure that the proceedings focused on the 
Advisers' compliance with fundamental fiduciary norms.
    Some commenters opposed the fiduciary acknowledgment requirement in 
the proposal, as applicable to Financial Institutions, on the basis 
that it could force Financial Institutions to take on fiduciary 
responsibilities, even if they would not otherwise be functional 
fiduciaries under ERISA or the Code. The commenters pointed out that 
under the proposed Regulation, the acknowledgment of fiduciary status 
would have been a factor in imposing fiduciary status on a party. 
Therefore, Financial Institutions could become fiduciaries by virtue of 
the fiduciary acknowledgment. To address these concerns, a few 
commenters suggested language under which a Financial Institution would 
only be considered a fiduciary to the extent that it is ``an affiliate 
of the Adviser within the meaning of 29 CFR 2510.3-21(f)(7) that, with 
the Adviser, functions as a fiduciary.''
    The Department has not adjusted the exemption as these commenters 
requested. The exemption requires as a condition of relief that a 
sponsoring Financial Institution accept fiduciary responsibility for 
the recommendations of its Adviser(s). The Financial Institution's role 
in supervising individual Advisers and overseeing their adherence to 
the Impartial Conduct Standards is a key safeguard of the exemption. 
The exemption's success critically depends on the Financial 
Institution's careful implementation of anti-conflict policies and 
procedures, avoidance of Adviser incentives to violate the Impartial 
Conduct Standards and broad oversight of Advisers. Accordingly, 
Financial Institutions that wish to engage in principal transactions 
and riskless principal transactions that would otherwise be prohibited 
under ERISA and the Code must agree to take on these responsibilities 
as a condition of relief under the exemption. To the extent Financial 
Institutions do not wish to take on this role with their associated 
responsibilities and liabilities, they may structure their operations 
to avoid prohibited transactions and the resultant need of the 
exemption.
    Other commenters expressed the view that the fiduciary 
acknowledgement would potentially require broker-dealers to satisfy the 
requirements of the Investment Advisers Act of 1940. As described by 
commenters, the Act does not require broker-dealers to register as 
investment advisers if they provide advice that is solely incidental to 
their brokerage services. Commenters expressed concern that 
acknowledging fiduciary status and providing advice in satisfaction of 
the Impartial Conduct Standards could call into question whether the 
advice provided was solely incidental.
    The Department does not, however, require the Adviser or Financial 
Institution to acknowledge fiduciary status under the securities laws, 
but rather under ERISA or the Code or both. Neither does the Department 
require Advisers to agree to provide investment advice on an ongoing, 
rather than transactional, basis. An Adviser's status as an ERISA 
fiduciary is not dispositive of its obligations under the securities 
laws, and compliance with the

[[Page 21105]]

exemption does not trigger an automatic loss of the broker-dealer 
exception under the separate requirements of those laws. A broker-
dealer who provides investment advice under the Regulation is an ERISA 
fiduciary; acknowledgment of ERISA fiduciary status would not, by 
itself, cause the Adviser to lose the broker-dealer exception. Under 
the Regulation and this exemption, the primary import of fiduciary 
status is that the broker has to act in the customer's Best Interest 
when making recommendations; seek to obtain the best execution 
reasonably available under the circumstances with respect to the 
transaction; and refrain from making misleading statements. Certainly, 
nothing in the securities laws precludes brokers from adhering to these 
basic standards, or forbids them from working for Financial 
Institutions that implement appropriate policies and procedures to 
ensure that these standards are met.
    The Department changed the fiduciary acknowledgment provision in 
response to several comments requesting revisions to clarify the 
required extent of the fiduciary acknowledgment. Accordingly, the 
Department has clarified that the acknowledgment can be limited to 
investment recommendations subject to the contract or, in the case of 
an ERISA plan, any investment recommendations regarding the plan or 
beneficiary or participant account. As discussed in more detail below, 
the exemption (including the required fiduciary acknowledgment) does 
not in and of itself, impose an ongoing duty to monitor on the Adviser 
and Financial Institution. However, there may be some investments which 
cannot be prudently recommended for purchase to individual Retirement 
Investors, in the first place, without a mechanism in place for the 
ongoing monitoring of the investment.
4. Impartial Conduct Standards--Section II(c)
    Section II(c) of the exemption requires that the Adviser and 
Financial Institution comply with fundamental Impartial Conduct 
Standards. Generally stated, the Impartial Conduct Standards require 
that Advisers and Financial Institutions provide investment advice 
regarding the principal transaction or riskless principal transaction 
that is in the Retirement Investor's Best Interest, seek to obtain the 
best execution reasonably available under the circumstances with 
respect to the transaction, and not make misleading statements to the 
Retirement Investor about the recommended transaction and Material 
Conflicts of Interest. As defined in the exemption, a Financial 
Institution and Adviser act in the Best Interest of a Retirement 
Investor when they provide investment advice that reflects ``the care, 
skill, prudence, and diligence under the circumstances then prevailing 
that a prudent person acting in a like capacity and familiar with such 
matters would use in the conduct of an enterprise of a like character 
and with like aims, based on the investment objectives, risk tolerance, 
financial circumstances, and needs of the Retirement Investor, without 
regard to the financial or other interests of the Adviser, Financial 
Institution, any Affiliate or other party.''
    The Impartial Conduct Standards represent fundamental obligations 
of fair dealing and fiduciary conduct. The concepts of prudence, 
undivided loyalty and reasonable compensation are all deeply rooted in 
ERISA and the common law of agency and trusts.\22\ These longstanding 
concepts of law and equity were developed in significant part to deal 
with the issues that arise when agents and persons in a position of 
trust have conflicting loyalties, and accordingly, are well-suited to 
the problems posed by conflicted investment advice. The phrase 
``without regard to'' is a concise expression of ERISA's duty of 
loyalty, as expressed in section 404(a)(1)(A) of ERISA and applied in 
the context of advice. It is consistent with the formulation stated in 
the common law, and it is consistent with the language used by Congress 
in Section 913(g)(1) of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the Dodd-Frank Act),\23\ and cited in the Staff of the 
U.S. Securities and Exchange Commission ``Study on Investment Advisers 
and Broker-Dealers as Required by Section 913 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act'' (Jan. 2011) (SEC staff 
Dodd-Frank Study).\24\
---------------------------------------------------------------------------

    \22\ See generally ERISA sections 404(a), 408(b)(2); Restatement 
(Third) of Trusts section 78 (2007), and Restatement (Third) of 
Agency section 8.01.
    \23\ Section 913(g) of the Dodd-Frank Act governs ``Standard of 
Conduct'' and subsection (1) provides that ``The Commission may 
promulgate rules to provide that the standard of conduct for all 
brokers, dealers, and investment advisers, when providing 
personalized investment advice about securities to retail customers 
(and such other customers as the Commission may by rule provide), 
shall be to act in the best interest of the customer without regard 
to the financial or other interest of the broker, dealer, or 
investment adviser providing the advice.''
    \24\ SEC Staff Study on Investment Advisers and Broker-Dealers, 
January 2011, available at https://www.sec.gov/news/studies/2011/913studyfinal.pdf, pp. 109-110.
---------------------------------------------------------------------------

    Under ERISA section 408(a) and Code section 4975(c)(2), the 
Department cannot grant an exemption unless it first finds that the 
exemption is administratively feasible, in the interests of plans and 
their participants and beneficiaries and IRA owners, and protective of 
the rights of participants and beneficiaries of plans and IRA owners. 
An exemption permitting transactions that violate the Impartial Conduct 
Standards would fail these standards.
    The Impartial Conduct Standards are conditions of the exemption for 
the provision of advice with respect to all Retirement Investors. For 
advice to Retirement Investors in IRAs and non-ERISA plans, the 
Impartial Conduct Standards must also be included as contractual 
commitments on the part of the Financial Institution and its Advisers. 
As noted above, there is no contract requirement for advice with 
respect Retirement Investors in ERISA plans.
    Comments on each of the Impartial Conduct Standards are discussed 
below. Additionally, in response to commenters' assertion that the 
exemption is not administratively feasible due to uncertainty regarding 
some terms and requests for additional clarity, the Department has 
clarified some key terms in the text and provides additional 
interpretive guidance in the preamble discussion that follows. Finally, 
the Department discusses comments on the treatment of the Impartial 
Conduct Standards as both exemption conditions for all Retirement 
Investors as well as contractual representations with respect to IRAs 
and other non-ERISA Plans.
a. Best Interest Standard
    Under Section II(c)(1), the Financial Institution must state that 
it and its Advisers will comply with a Best Interest standard when 
providing investment advice to the Retirement Investor with respect to 
principal transactions and riskless principal transactions, and, in 
fact, adhere to the standard. Advice in the Retirement Investor's Best 
Interest means advice that, at the time of the recommendation:

reflects the care, skill, prudence, and diligence under the 
circumstances then prevailing that a prudent person acting in a like 
capacity and familiar with such matters would use in the conduct of 
an enterprise of a like character and with like aims, based on the 
investment objectives, risk tolerance, financial circumstances, and 
needs of the Retirement Investor, without regard to the financial or 
other interests of the Adviser, Financial Institution or any 
Affiliate, or other party.

    The Best Interest standard set forth in the exemption is based on 
longstanding

[[Page 21106]]

concepts derived from ERISA and the law of trusts. It is meant to 
express the concept, set forth in ERISA section 404, that a fiduciary 
is required to act ``solely in the interest of the participants . . . 
with the care, skill, prudence, and diligence under the circumstances 
then prevailing that a prudent man acting in a like capacity and 
familiar with such matters would use in the conduct of an enterprise of 
a like character and with like aims.'' Similarly, both ERISA section 
404(a)(1)(A) and the trust-law duty of loyalty require fiduciaries to 
put the interests of trust beneficiaries first, without regard to the 
fiduciaries' own self-interest. Under this standard, for example, an 
Adviser, in choosing between two investments, could not select an 
investment because it is better for the Adviser's or Financial 
Institution's bottom line, even though it is a worse choice for the 
Retirement Investor.
    A wide range of commenters indicated support for a broad Best 
Interest standard. Some comments indicated that the Best Interest 
standard is consistent with the way Advisers provide investment advice 
to clients today. However, a number of these commenters expressed 
misgivings as to the definition used in the proposed exemption, in 
particular, the ``without regard to'' formulation. The commenters 
indicated uncertainty as to the meaning of the phrase, including 
whether it effectively precluded an Adviser from receiving compensation 
if a particular investment would generate higher Adviser compensation.
    Other commenters asked the Department to use a different definition 
of Best Interest, or simply use the exact language from ERISA's section 
404 duty of loyalty. Others suggested definitional approaches that 
would require that the Adviser and Financial Institution ``not 
subordinate'' their customers' interests to their own interests, or 
that the Adviser and Financial Institution ``put their customers' 
interests ahead of their own interests,'' or similar constructs.
    FINRA suggested that the federal securities laws should form the 
foundation of the Best Interest standard. Specifically, FINRA urged 
that the Best Interest definition in the exemption incorporate the 
suitability standard applicable to investment advisers and broker 
dealers under federal securities laws. According to FINRA, this would 
facilitate customer enforcement of the Best Interest standard by 
providing adjudicators with a well-established basis on which to find a 
violation.
    Other commenters found the Best Interest standard to be an 
appropriate statement of the obligations of a fiduciary investment 
advice provider and believed it would provide concrete protections 
against conflicted recommendations. These commenters asked the 
Department to maintain the Best Interest definition as proposed. One 
commenter wrote that the term ``best interest'' is commonly used in 
connection with a fiduciary's duty of loyalty and cautioned the 
Department against creating an exemption that failed to include the 
duty of loyalty. Others urged the Department to avoid definitional 
changes that would reduce current protections to Retirement Investors. 
Some commenters also noted that the ``without regard to'' language is 
consistent with the recommended standard in the SEC staff Dodd-Frank 
Study, and suggested that it has added benefit of potentially 
harmonizing with a future securities law standard for broker-dealers.
    In the context of principal transactions, one commenter suggested 
that the Department make clear that both the advice and the execution 
of the transaction must be in the Retirement Investor's Best Interest. 
The Department agrees that the execution of the transaction is an 
important concern, and has incorporated in Section II(c)(2) of the 
exemption, a provision requiring Financial Institutions that are FINRA 
members to agree that they and their Advisers and Financial Institution 
will comply with the terms of FINRA rule 5310 (Best Execution and 
Interpositioning).
    The final exemption retains the Best Interest definition as 
proposed, with minor adjustments. The first prong of the standard was 
revised to more closely track the statutory language of ERISA section 
404(a), and, is consistent with the Department's intent to hold 
investment advice fiduciaries to a prudent investment professional 
standard. Accordingly, the definition of Best Interest now requires 
advice that ``reflects the care, skill, prudence, and diligence under 
the circumstances then prevailing that a prudent person acting in a 
like capacity and familiar with such matters would use in the conduct 
of an enterprise of a like character and with like aims, based on the 
investment objectives, risk tolerance, financial circumstances, and 
needs of the Retirement Investor . . .'' The exemption adopts the 
second prong of the proposed definition, ``without regard to the 
financial or other interests of the Adviser, Financial Institution or 
any Affiliate or other party,'' without change. The Department 
continues to believe that the ``without regard to'' language sets forth 
the appropriate, protective standard under which a fiduciary investment 
adviser should act. The standard ensures that the advice will not be 
tainted by self-interest. Under this language, an Adviser and Financial 
Institution must make a recommendation with respect to the principal 
transaction or riskless principal transaction without considering their 
own financial or other interests, or those of their Affiliates, or 
others. They may not recommend such a transaction on the basis that it 
pays them more, or otherwise benefits them more than a transaction 
conducted on an agency basis. Many of the alternative approaches 
suggested by commenters pose their own ambiguities and interpretive 
challenges, and lower standards run the risk of undermining this 
regulatory initiative's goal of reducing the impact of conflicts of 
interest on Retirement Investors.
    The Department has not specifically incorporated the suitability 
obligation as an element of the Best Interest standard, as suggested by 
FINRA but many aspects of suitability are also elements of the Best 
Interest standard. An investment recommendation that is not suitable 
under the securities laws would not meet the Best Interest standard. 
Under FINRA's rule 2111(a) on suitability, broker-dealers ``must have a 
reasonable basis to believe that a recommended transaction or 
investment strategy involving a security or securities is suitable for 
the customer.'' The text of rule 2111(a), however, does not do any of 
the following: Reference a best interest standard, clearly require 
brokers to put their client's interests ahead of their own, expressly 
prohibit the selection of the least suitable (but more remunerative) of 
available investments, or require them to take the kind of measures to 
avoid or mitigate conflicts of interests that are required as 
conditions of this exemption.
    The Department recognizes that FINRA issued guidance on rule 2111 
in which it explains that ``in interpreting the suitability rule, 
numerous cases explicitly state that a broker's recommendations must be 
consistent with his customers' best interests,'' and provided examples 
of conduct that would be prohibited under this standard, including 
conduct that this exemption would not allow.\25\ The guidance goes on 
to state that ``[t]he suitability requirement that a broker make only 
those recommendations that are consistent with the customer's best 
interests prohibits a broker from placing his or her interests ahead of 
the customer's interests.'' The Department, however is reluctant to 
adopt as an

[[Page 21107]]

express standard such guidance, which has not been formalized as a 
clear rule and that, in any case, may be subject to change. 
Additionally, FINRA's suitability rule may be subject to 
interpretations which could conflict with interpretations by the 
Department, and the cases cited in the FINRA guidance, as read by the 
Department, involved egregious fact patterns that one would have 
thought violated the suitability standard even without reference to the 
customer's best interest.
---------------------------------------------------------------------------

    \25\ FINRA Regulatory Notice 12-25, p. 3 (2012).
---------------------------------------------------------------------------

    Moreover, suitability under SEC practice differs somewhat from the 
FINRA approach. According to the SEC staff Dodd-Frank Study, the SEC 
requirements are based on the anti-fraud provisions of the Securities 
Act Section 17(a), the Exchange Act Section 10(b) and Rule 10b-5 
thereunder.\26\ As a general matter, SEC Rule 10b-5 prohibits any 
person, directly or indirectly, from: (a) Employing any device, scheme, 
or artifice to defraud; (b) making untrue statements of material fact 
or omitting to state a material fact necessary in order to make the 
statements made, in the light of the circumstances, not misleading; or 
(c) engaging in any act or practice or course of business which 
operates or that would operate as a fraud or deceit upon any person in 
connection with the purchase or sale of any security. FINRA does not 
require scienter, but the weight of authority holds that violations of 
the Self-Regulatory Organization rules, standing alone, do not give 
right to a private cause of action. Courts, however, allow private 
claims for violations of SEC Rule 10b-5 for fraud claims, including, 
among others, unsuitable recommendations. The private plaintiff must 
establish that the broker's unsuitable recommendation involved a 
misrepresentation (or material omission) made with scienter. 
Accordingly, after review of the issue, the Department has decided not 
to accept the comment. The Department has concluded that its 
articulation of a clear loyalty standard within the exemption, rather 
than by reference to the FINRA guidance, will provide clarity and 
certainty to investors, and better protect their interests.
---------------------------------------------------------------------------

    \26\ SEC staff Dodd-Frank Study at 61.
---------------------------------------------------------------------------

    The Best Interest standard, as set forth in the exemption, is 
intended to effectively incorporate the objective standards of care and 
undivided loyalty that have been applied under ERISA for more than 
forty years. Under these objective standards, the Adviser must adhere 
to a professional standard of care in making investment recommendations 
regarding principal transactions and riskless principal transactions 
that are in the Retirement Investor's Best Interest. The Adviser may 
not base his or her recommendations on the Adviser's own financial 
interest in the transaction. Nor may the Adviser recommend a principal 
transaction or riskless principal transaction, unless it meets the 
objective prudent person standard of care. Additionally, the duties of 
loyalty and prudence embodied in ERISA are objective obligations that 
do not require proof of fraud or misrepresentation, and full disclosure 
is not a defense to making an imprudent recommendation or favoring 
one's own interests at the Retirement Investor's expense.
    A few commenters also questioned the requirement in the Best 
Interest standard that recommendations be made without regard to the 
interests of the Adviser, Financial Institution, any Affiliate, or 
other party. The commenters indicated they did not know the purpose of 
the reference to ``other party'' and asked that it be deleted. The 
Department intends the reference to make clear that an Adviser and 
Financial Institution operating within the Impartial Conduct Standards 
should not take into account the interests of any party other than the 
Retirement Investor--whether the other party is related to the Adviser 
or Financial Institution or not--in making a recommendation regarding a 
principal transaction or riskless principal transaction. For example, 
an entity that may be unrelated to the Adviser or Financial Institution 
but could still constitute an ``other party,'' for these purposes, is 
the manufacturer of the investment product being recommended.
    Other commenters asked for confirmation that the Best Interest 
standard is applied based on the facts and circumstances as they 
existed at the time of the recommendation, and not based on hindsight. 
Consistent with the well-established legal principles that exist under 
ERISA today, the Department confirms that the Best Interest standard is 
not a hindsight standard, but rather is based on the facts as they 
existed at the time of the recommendation. Thus, the courts have 
evaluated the prudence of a fiduciary's actions under ERISA by focusing 
on the process the fiduciary used to reach its determination or 
recommendation--whether the fiduciary, ``at the time they engaged in 
the challenged transactions, employed the proper procedures to 
investigate the merits of the investment and to structure the 
investment.'' \27\ The standard does not measure compliance by 
reference to how investments subsequently performed or turn Advisers 
and Financial Institutions into guarantors of investment performance, 
even though they gave advice that was prudent and loyal at the time of 
transaction.\28\
---------------------------------------------------------------------------

    \27\ Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983).
    \28\ One commenter requested an adjustment to the ``prudence'' 
component of the Best Interest standard, under which the standard 
would be that of a ``prudent person serving clients with similar 
retirement needs and offering a similar array of products.'' In this 
way, the commenter sought to accommodate varying perspectives and 
opinions on particular investment products and business practices. 
The Department disagrees with the comment, which could be read as 
qualifying the stringency of the prudence obligation based on the 
Financial Institution's or Adviser's independent decisions on which 
products to offer, rather than on the needs of the particular 
Retirement Investor. Therefore, the Department did not adopt this 
suggestion.
---------------------------------------------------------------------------

    This is not to suggest that the ERISA section 404 prudence 
standard, or Best Interest standard, are solely procedural standards. 
Thus, the prudence standard, as incorporated in the Best Interest 
standard, is an objective standard of care that requires investment 
advice fiduciaries to investigate and evaluate investments, make 
recommendations, and exercise sound judgment in the same way that 
knowledgeable and impartial professionals would. ``[T]his is not a 
search for subjective good faith--a pure heart and an empty head are 
not enough.'' \29\ Whether or not the fiduciary is actually familiar 
with the sound investment principles necessary to make particular 
recommendations, the fiduciary must adhere to an objective professional 
standard. Additionally, fiduciaries are held to a particularly 
stringent standard of prudence when they have a conflict of 
interest.\30\ For this reason, the Department declines to provide a 
safe harbor based on ``procedural prudence'' as requested by a 
commenter.
---------------------------------------------------------------------------

    \29\ Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983), 
cert. denied, 467 U.S. 1251 (1984); see also DiFelice v. U.S. 
Airways, Inc., 497 F.3d 410, 418 (4th Cir. 2007) (``Good faith does 
not provide a defense to a claim of a breach of these fiduciary 
duties; `a pure heart and an empty head are not enough.''').
    \30\ Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982) 
(``the[] decisions [of the fiduciary] must be made with an eye 
single to the interests of the participants and beneficiaries''); 
see also Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 298 (5th Cir. 
2000); Leigh v. Engle, 727 F.2d 113, 126 (7th Cir. 1984).
---------------------------------------------------------------------------

    The Department additionally confirms its intent that the phrase 
``without regard to'' be given the same meaning as the language in 
ERISA section 404 that requires a fiduciary to act ``solely in the 
interest of'' participants and

[[Page 21108]]

beneficiaries, as such standard has been interpreted by the Department 
and the courts. Therefore, the standard would not, as some commenters 
suggested, foreclose the Adviser and Financial Institution from being 
paid. The Department confirms that the standard does not preclude the 
Financial Institution from receiving reasonable compensation or from 
recouping the cost of obtaining and carrying the security, assuming the 
investment remains prudent when all its costs are considered.
    In response to commenter concerns, the Department also confirms 
that the Best Interest standard does not impose an unattainable 
obligation on Advisers and Financial Institutions to somehow identify 
the single ``best'' investment for the Retirement Investor out of all 
the investments in the national or international marketplace, assuming 
such advice or management were even possible. Instead, as discussed 
above, the Best Interest standard set out in the exemption, 
incorporates two fundamental and well-established fiduciary 
obligations: the duties of prudence and loyalty. Thus, the fiduciary's 
obligation under the Best Interest standard is to give advice or 
acquire or dispose of investments in a manner that adheres to 
professional standards of prudence, and to put the Retirement 
Investor's financial interests in the driver's seat, rather than the 
competing interests of the Adviser or other parties.
    Finally, in response to questions regarding the extent to which 
this Best Interest standard or other provisions of the exemption impose 
an ongoing monitoring obligation on Advisers or Financial Institutions, 
the Department has added specific language in Section II(e) regarding 
monitoring. The text does not impose a monitoring requirement, but 
instead requires clarity. As suggested by FINRA, Section II(e) requires 
Advisers and Financial Institutions to disclose whether or not they 
will monitor the Retirement Investor's investments and alert the 
Retirement Investor to any recommended changes to those investments 
and, if so, the frequency with which the monitoring will occur and the 
reasons for which the Retirement Investor will be alerted. This is 
consistent with the Department's interpretation of an investment advice 
fiduciary's monitoring responsibility as articulated in the preamble to 
the Regulation.
    The terms of the contract or disclosure along with other 
representations, agreements, or understandings between the Adviser, 
Financial Institution and Retirement Investor, will govern whether the 
nature of the relationship between the parties is ongoing or not. The 
preamble to the proposed Best Interest Contract Exemption stated that 
adherence to a Best Interest standard did not mandate an ongoing or 
long-term relationship, but instead left the determination of whether 
to enter into such a relationship to the parties.\31\ This exemption 
builds upon this and requires that the contract clearly state the 
nature of the relationship and whether there is any duty to monitor on 
the part of the Adviser or Financial Institution. Whether the Adviser 
and Financial Institution, in fact, have an obligation to monitor the 
investment and provide long-term advice depends on the parties' 
reasonable understandings, arrangements, and agreements.
---------------------------------------------------------------------------

    \31\ 80 FR 21969 (Apr. 20, 2015).
---------------------------------------------------------------------------

b. Best Execution
    Section II(c)(2) of the exemption requires that the Adviser and 
Financial Institution seek to obtain the best execution reasonably 
available under the circumstances with respect to the principal 
transaction or riskless principal transaction with the plan, 
participant or beneficiary account or IRA.
    Section II(c)(2)(i) further provides that Financial Institutions 
that are FINRA members may satisfy Section II(c)(2) by complying with 
the terms of FINRA rules 2121 (Fair Prices and Commissions) and 5310 
(Best Execution and Interpositioning), or any successor rules in effect 
at the time of the transaction,\32\ as interpreted by FINRA, with 
respect to the principal transaction or riskless principal transaction.
---------------------------------------------------------------------------

    \32\ Accordingly, to the extent FINRA rules 2121 (Fair Prices 
and Commissions) or 5310 (Best Execution and Interpositioning) are 
amended, the Adviser and Financial Institution must comply with the 
requirements that are in effect at the time the transaction occurs.
---------------------------------------------------------------------------

    This provision is revised from the proposal, which provided that 
the purchase or sales price could not be unreasonable under the 
circumstances. Commenters on the proposal indicated that they were 
uncertain as to what an unreasonable price would be and requested 
additional clarification of the rule.
    Further, some commenters indicated that FINRA rule 2121 (Fair 
Prices and Commissions) should be incorporated in the alternative. 
According to FINRA, rule 2121 ``prohibits a broker-dealer from entering 
into a transaction with a customer `at any price' that is not 
reasonably related to the current market price of the security.'' FINRA 
additionally recommended that the Department incorporate FINRA rule 
5310 (Best Execution and Interpositioning) instead of its proposed two-
quote requirement (discussed below). According to FINRA:

    [Rule 5310] uses a ``facts and circumstances'' analysis by 
requiring that a firm dedicate reasonable diligence to ascertain the 
best market for the security and to buy or sell in such market so 
that the price to the customer is as favorable as possible under the 
prevailing market conditions. A key determinant in assessing whether 
a firm has met this reasonable diligence standard is the character 
of the market for the security itself, which includes an analysis of 
price, volatility and relative liquidity.
    [The] Rule . . . also addresses instances in which there is 
limited quotation or pricing information available. The rule 
requires a broker-dealer to have written policies and procedures 
that address how the firm will determine the best inter-dealer 
market for such a security in the absence of pricing information or 
multiple quotations and to document its compliance with those 
policies and procedures.

    After consideration of the comments received, the Department 
revised the proposed condition to focus on best execution, rather than 
an unreasonable price. The Department determined that a requirement 
that Advisers and Financial Institutions seek to obtain the best 
execution reasonably available under the circumstances with respect to 
the transaction, particularly as articulated by FINRA in rule 5310, 
would provide protections that are comparable to the Department's 
proposed condition but that are more familiar to the parties relying on 
the exemption.
    The Department specifically incorporated FINRA rules 2121 and 5310 
for FINRA members, as a method of satisfying this requirement, as 
suggested by some commenters. For Advisers and Financial Institutions 
that are not FINRA members, the best execution obligation under the 
exemption is satisfied if the Adviser and Financial Institution 
satisfies the best execution obligation as interpreted by their 
functional regulator. However, to the extent non-FINRA members wish for 
additional certainty as to their compliance obligations under this 
exemption, they may comply with the provisions of FINRA rules 2121 and 
5310 to satisfy Section II(c)(2).
    Under Section II(c)(2)(ii), if the Department expands the scope of 
this exemption to include additional principal traded assets by 
individual exemption,\33\ the Department may

[[Page 21109]]

identify specific alternative best execution and fair pricing 
requirements imposed by another regulator or self-regulatory 
organization that must be complied with. This would potentially permit, 
for example, Financial Institutions to cite specific requirements of 
the Municipal Securities Rulemaking Board, if municipal securities 
become covered under the exemption.
---------------------------------------------------------------------------

    \33\ See Section VI(j)(1)(iv).
---------------------------------------------------------------------------

c. Misleading Statements
    The final Impartial Conduct Standard, set forth in Section 
II(c)(3), requires that statements by the Financial Institution and its 
Advisers to the Retirement Investor about the recommended transaction, 
fees and compensation, Material Conflicts of Interest, and any other 
matters relevant to a Retirement Investor's investment decision to 
engage in a principal transaction or a riskless principal transaction, 
may not be materially misleading at the time they are made. In response 
to commenters, the Department adjusted the text to clarify that the 
standard is measured at the time of the representations, i.e., the 
statements must not be misleading ``at the time they are made.'' 
Similarly, the Department added a materiality standard in response to 
comments.
    The Department did not accept certain other comments, however. One 
commenter requested that the Department add a qualifier providing that 
the standard is violated only if the statement was ``reasonably 
relied'' on by the Retirement Investor. The Department rejected the 
comment. The Department's aim is to ensure that Financial Institutions 
and Advisors uniformly adhere to the Impartial Conduct Standards, 
including the obligation to avoid materially misleading statements, 
when they give advice. Whether a Retirement Investor relied on a 
particular statement may be relevant to the question of damages in 
subsequent arbitration or court proceedings, but it is not and should 
not be relevant to the question of whether the fiduciary violated the 
exemption's standards in the first place. Moreover, inclusion of a 
reasonable reliance standard runs the risk of inviting boilerplate 
disclaimers of reliance in contracts and disclosure documents precisely 
so the Adviser can assert that any reliance is unreasonable.
    One commenter asked the Department to require only that the Adviser 
``reasonably believe'' the statements are not misleading. The 
Department is concerned that this standard too could undermine the 
protections of this condition, by requiring Retirement Investors or the 
Department to prove the Adviser's actual belief rather than focusing on 
whether the statement is objectively misleading. However, to address 
commenters' concerns about the risks of engaging in a prohibited 
transaction, as noted above, the Department has clarified that the 
standard is measured at the time of the representations and has added a 
materiality standard.
    The Department believes that Retirement Investors are best served 
by statements and representations that are free from material 
misstatements. Financial Institutions and Advisers best avoid 
liability--and best promote the interests of Retirement Investors--by 
ensuring that accurate communications are a consistent standard in all 
their interactions with their customers.
    A commenter suggested that the Department adopt FINRA's 
``Frequently Asked Questions regarding Rule 2210'' in this 
connection.\34\ FINRA's rule 2210, Communications with the Public, sets 
forth a number of procedural rules and standards that are designed to, 
among other things, prevent broker-dealer communications from being 
misleading. The Department agrees that adherence to FINRA's standards 
can promote materially accurate communications, and certainly believes 
that Financial Institutions and Advisers should pay careful attention 
to such guidance documents. After review of the rule and FAQs, however, 
the Department declines to simply adopt FINRA's guidance, which 
addresses written communications, since the condition of the exemption 
is broader in this respect. In the Department's view, the meaning of 
the standard is clear, and is already part of a plan fiduciary's 
obligations under ERISA. If, however, issues arise in implementation of 
the exemption, the Department will consider requests for additional 
guidance.
---------------------------------------------------------------------------

    \34\ Currently available at http://www.finra.org/industry/finra-rule-2210-questions-and-answers.
---------------------------------------------------------------------------

d. Contractual Representation Versus Exemption Condition
    Commenters expressed a variety of views on whether violations of 
the Impartial Conduct Standards with respect to advice regarding 
principal transactions to Retirement Investors regarding IRAs and non-
ERISA plans should result in loss of the exemption, violation of the 
contract, or both.\35\ Some commenters objected to the incorporation of 
the Impartial Conduct Standards as contract terms, generally, on the 
basis that the requirement would contribute to litigation risk. Some 
commenters preferred that the Impartial Conduct Standards only be 
required as a condition of the exemption, and not give rise to contract 
claims.
---------------------------------------------------------------------------

    \35\ Commenters also asserted that the Department did not have 
the authority to condition the exemption on the Impartial Conduct 
Standards. Comments on the Department's jurisdiction are discussed 
in a separate Section D. of this preamble.
---------------------------------------------------------------------------

    Other commenters advocated for the opposite result, asserting that 
the Impartial Conduct Standards should be required for contractual 
promises only, and not treated as exemption conditions. These 
commenters asserted that the Impartial Conduct Standards are too vague 
and would result in uncertainty as to whether an excise tax under the 
Code, which is self-assessed, is owed. There were also suggestions to 
limit the contractual representation to the Best Interest standard 
alone. One commenter asserted that the favorable price requirement and 
the obligation not to make misleading statements fall within a Best 
Interest standard, and do not need to be stated separately. There were 
also suggestions that the Impartial Conduct Standards not apply to 
ERISA plans because fiduciaries to these plans already are required to 
adhere to similar statutory fiduciary obligations. In these commenters' 
views, requiring these standards in an exemption is redundant and 
inappropriately increases the consequences of any fiduciary breach by 
imposing an excise tax.
    In response to comments, the Department has revised the language of 
the Impartial Conduct Standards and provided interpretive guidance to 
alleviate the commenters' concerns about uncertainty and litigation 
risk. However, the Department has concluded that, failure to adhere to 
the Impartial Conduct Standards should be both a violation of the 
contract (where required) and the exemption. Accordingly, the 
Department has not eliminated any of the conduct standards or, for IRAs 
and non-ERISA plans, restricted them just to conditions of the 
exemption for Retirement Investors investing in IRAs or non-ERISA 
plans. In the Department's view, all the Impartial Conduct Standards 
form the baseline standards that should be applicable to fiduciaries 
relying on the exemption; therefore, the Department has not accepted 
comments suggesting that the contract representation be limited to the 
Best Interest standard. Making all the Impartial Conduct Standards 
required contractual promises for dealings with IRAs and other non-
ERISA plans creates the potential for contractual liability, 
incentivizes Financial Institutions to comply, and gives injured 
Retirement Investors a remedy if those Financial Institutions do not 
comply. This enforceability is critical to the safeguards afforded by 
the exemption.

[[Page 21110]]

    As previously discussed, the Impartial Conduct Standards will not 
unduly increase litigation risk. The standards are not unduly vague or 
unknown, but rather track longstanding concepts in law and equity. 
Also, the Department has simplified execution of the contract, 
streamlined disclosure, and made certain language changes to address 
legitimate concerns.
    Similarly, the Department has not accepted the comment that the 
Impartial Conduct Standards should apply only to IRAs and non-ERISA 
plans. One of the Department's goals is to ensure equal footing for all 
Retirement Investors. The SEC staff Dodd-Frank Study found that 
investors were frequently confused by the differing standards of care 
applicable to broker-dealers and registered investment advisers. The 
Department hopes to minimize such confusion in the market for 
retirement advice by holding Advisers and Financial Institutions to 
similar standards, regardless of whether they are giving the advice to 
an ERISA plan, IRA, or a non-ERISA plan.
    Moreover, inclusion of the standards in the exemption's conditions 
adds an important additional safeguard for ERISA and IRA investors 
alike because the party engaging in a prohibited transaction has the 
burden of showing compliance with an applicable exemption, when 
violations are alleged.\36\ In the Department's view, this burden-
shifting is appropriate because of the dangers posed by conflicts of 
interest, as reflected in the Department's Regulatory Impact Analysis 
and because of the difficulties Retirement Investors have in 
effectively policing such violations.\37\ One important way for 
Financial Institutions to ensure that they can meet this burden is by 
implementing strong anti-conflict policies and procedures, and by 
refraining from creating incentives to violate the Impartial Conduct 
Standards. Thus, treating the Impartial Conduct Standards as exemption 
conditions creates an important incentive for Financial Institutions to 
carefully monitor and oversee their Advisers' conduct for adherence 
with fiduciary norms.
---------------------------------------------------------------------------

    \36\ See, e.g., Fish v. GreatBanc Trust Company, 749 F.3d 671 
(7th Cir. 2014).
    \37\ See Regulatory Impact Analysis.
---------------------------------------------------------------------------

    Moreover, as noted repeatedly, the language for the Impartial 
Conduct Standards borrows heavily from ERISA and the law of trusts, 
providing sufficient clarity to alleviate the commenters' concerns. 
Ensuring that fiduciary investment advisers adhere to the Impartial 
Conduct Standards and that all Retirement Investors have an effective 
legal mechanism to enforce the standards are central goals of this 
regulatory project.
5. Sales Incentives and Anti-Conflict Policies and Procedures
    Under Section II(d)(1)-(3) of the exemption, the Financial 
Institution is required to adopt certain anti-conflict policies and 
procedures and to insulate Advisers from incentives to violate the Best 
Interest standard. In order for relief to be available under the 
exemption, a Financial Institution that meets the definition set forth 
in the exemption must provide oversight of Advisers' recommendations, 
as described in this section. The Financial Institution must prepare a 
written document describing the Financial Institution's policies and 
procedures, and make copies of the document readily available to 
Retirement Investors, free of charge, upon request as well as on the 
Financial Institution's Web site.\38\ The written description must 
accurately describe or summarize key components of the policies and 
procedures relating to conflict-mitigation and incentive practices in a 
manner that permits Retirement Investors to make an informed judgment 
about the stringency of the Financial Institution's protections against 
conflicts of interest. The Department opted against requiring 
disclosure of the full policies and procedures to Retirement Investors 
to avoid giving them a potentially overwhelming amount of information 
that could run contrary to its purpose (e.g., by alerting Advisers to 
the particular surveillance mechanisms employed by Financial 
Institutions). However, the exemption requires that the full policies 
and procedures must be made available to the Department upon request.
---------------------------------------------------------------------------

    \38\ See Section IV(e).
---------------------------------------------------------------------------

    These obligations have several important components. First, the 
Financial Institution must adopt and comply with written policies and 
procedures reasonably and prudently designed to ensure that its 
individual Advisers adhere to the Impartial Conduct Standards set forth 
in Section II(c). Second, the Financial Institution in formulating its 
policies and procedures, must specifically identify and document its 
Material Conflicts of Interest associated with principal transactions 
and riskless principal transactions; adopt measures reasonably and 
prudently designed to prevent Material Conflicts of Interest from 
causing violations of the Impartial Conduct Standards set forth in 
Section II(c); and designate a person or persons, identified by name, 
title or function, responsible for addressing Material Conflicts of 
Interest and monitoring Advisers' adherence to the Impartial Conduct 
Standards. For purposes of the exemption, a Material Conflict of 
Interest exists when an Adviser or Financial Institution has a 
financial interest that a reasonable person would conclude could affect 
the exercise of its best judgment as a fiduciary in rendering advice to 
a Retirement Investor.
    Finally, the Financial Institution's policies and procedures must 
require that, neither the Financial Institution nor (to the best of its 
knowledge) any Affiliate uses or relies on quotas, appraisals, 
performance or personnel actions, bonuses, contests, special awards, 
differential compensation or other actions or incentives that are 
intended or would reasonably be expected to cause individual Advisers 
to make recommendations regarding principal transactions and riskless 
principal transactions that are not in the Best Interest of the 
Retirement Investor.
    In this respect, however, the exemption makes clear that that 
requirement does not prevent the Financial Institution or its 
Affiliates from providing Advisers with differential compensation 
(whether in type or amount, and including, but not limited to, 
commissions) based on investment decisions by Plans, participant or 
beneficiary accounts, or IRAs, to the extent that the policies and 
procedures and incentive practices, when viewed as a whole, are 
reasonably and prudently designed to avoid a misalignment of the 
interests of Advisers with the interests of the Retirement Investors 
they serve as fiduciaries.
    The anti-conflict policies and procedures will safeguard the 
interests of Retirement Investors by causing Financial Institutions to 
consider the conflicts of interest affecting their provision of advice 
to Retirement Investors regarding principal transactions and riskless 
principal transactions and to take action to mitigate the impact of 
such conflicts. In particular, under the final exemption, Financial 
Institutions must not use compensation and other employment incentives 
to the extent they are intended to or would reasonably be expected to 
cause Advisers to make recommendations that are not in the Best 
Interest of the Retirement Investor. Financial Institutions must also 
establish a supervisory structure reasonably and prudently designed to 
ensure the Advisers will adhere to the

[[Page 21111]]

Impartial Conduct Standards. Mitigating conflicts of interest 
associated with principal transactions and riskless principal 
transactions by requiring greater alignment of the interests of the 
Adviser and Financial Institution, and the Retirement Investor, is 
necessary for the Department to make the findings under ERISA section 
408(a) and Code section 4975(c)(2) that the exemption is in the 
interests of, and protective of, Retirement Investors. This warranty 
gives the Financial Institution a powerful incentive to ensure advice 
is provided in accordance with fiduciary norms, rather than risk 
litigation, including class litigation and liability.
    Like the proposal, the exemption does not specify the precise 
content of the anti-conflict policies and procedures. This flexibility 
is intended to allow Financial Institutions to develop policies and 
procedures that are effective for their particular business models, 
while prudently ensuring compliance with their and their Advisers' 
fiduciary obligations and the Impartial Conduct Standards. The policies 
and procedures requirement, if taken seriously, can also reduce 
Financial Institutions' litigation risk by minimizing incentives for 
Advisers to provide advice that is not in Retirement Investors' Best 
Interest.
    As adopted in the final exemption, the policies and procedures 
requirement is a condition of the exemption for all Retirement 
Investors--in ERISA plans, IRAs and non-ERISA plans. Failure to comply 
could result in liability under ERISA for engaging in a prohibited 
transaction and the imposition of an excise tax under the Code, payable 
to the Treasury. Additionally, with respect to Retirement Investors in 
IRAs and non-ERISA plans, the requirements take the form of a 
contractual warranty. The Financial Institution must warrant that it 
has adopted and will comply with the anti-conflict policies and 
procedures (including the obligation to avoid misaligned incentives). 
Failure to comply with the warranty could result in contractual 
liability.
    Comments on the proposed policies and procedures requirement are 
discussed below. As stated above, for ease of use, the Department has 
included in this preamble the same general discussion of comments as in 
the Best Interest Contract Exemption, to the extent applicable to 
principal transactions and riskless principal transactions, despite the 
fact that some comments discussed below were not made directly with 
respect to this exemption.
a. Policies and Procedures Requirement Generally
    Under the policies and procedures requirement, described in greater 
detail above, Financial Institutions must adopt and comply with anti-
conflict policies and procedures. In addition, neither the Financial 
Institution nor (to the best of its knowledge) any Affiliates may use 
or rely on quotas, appraisals, performance or personnel actions, 
bonuses, contests, special awards, differential compensation or other 
actions or incentives that are intended or would reasonably be expected 
to cause Advisers to make recommendations that are not in the Best 
Interest of the Retirement Investor.
    Some commenters were extremely supportive of the policies and 
procedures requirement as proposed. They expressed the view that the 
policies and procedures requirement, and in particular the restrictions 
on compensation and other employment incentives, was one of the most 
critical investor protections in the proposal because it would cause 
Financial Institutions to make specific and necessary changes to their 
compensation arrangements that would result in significant protections 
to Retirement Investors.
    Some commenters believed that the Department did not go far enough. 
These commenters indicated that flat compensation arrangements should 
be required, or at least that the rules applicable to differential 
compensation should be more specific and stringent.
    A few commenters also indicated that, in addition to focusing on 
the Adviser, the Financial Institution's policies and procedures need 
to consider the impact of compensation practices on branch managers. A 
commenter indicated that branch managers have responsibilities under 
FINRA's supervisory rules to ensure suitability and possibly approve 
individual transactions. The commenter asserted that branch managers 
financially benefit from Advisers' recommendations and have a variety 
of methods of influencing Adviser behavior.
    Many others objected to the policies and procedures warranty and 
requested that it be eliminated in the final exemption. Some commenters 
believed that compliance would require drastic changes to current 
compensation arrangements or could possibly result in the complete 
prohibition of commissions and other transaction-based compensation. 
Other commenters suggested that the requirement should be eliminated as 
it would be unnecessary in light of the exemption's Best Interest 
standard, and because it would unnecessarily increase litigation risk 
to Financial Institutions. Alternatively, there were requests to 
clarify specific provisions and provide safe harbors in the policies 
and procedures requirement.
    In the final exemption, the Department has retained the general 
approach of the proposal. The Department concurs with commenters who 
view the policies and procedures requirement as an important safeguard 
for Retirement Investors and as a necessary condition for the 
Department to make the findings under ERISA section 408(a) and Code 
section 4975(c)(2) that the exemption is in the interests of, and 
protective of, Retirement Investors. This provision will require 
Financial Institutions to take concrete and specific steps to ensure 
that its individual Advisers adhere to the Impartial Conduct Standards, 
and in particular, forego compensation practices and employment 
incentives (quotas, appraisals, performance or personnel actions, 
bonuses, contests, special awards, differential compensation or other 
actions or incentives) that are intended or would reasonably be 
expected to cause Advisers to make recommendations that are not in the 
Best Interest of the Retirement Investor. Strong policies and 
procedures reduce the temptation (conscious or unconscious) to violate 
the Best Interest standard in the first place by ensuring that the 
Advisers' incentives are appropriately aligned with the interests of 
the customers they serve, and by ensuring appropriate monitoring and 
supervision of individual Advisers' conduct. While the Department views 
the Best Interest standard as critical to the protections of the 
exemption, the policies and procedures requirement is equally critical 
as a means of supporting Best Interest advice and protecting Retirement 
Investors from having to enforce the Best Interest standard after the 
advice has already been rendered and the damage done.
    The Department has not made the requirements more stringent, as 
suggested by some commenters, so as to require completely level 
compensation. The Department designed the exemption to preserve mark-
ups and mark-downs and other payments as applicable to the transaction 
in connection with principal transactions and riskless principal 
transactions, thereby preserving existing business models.
    The Department also adopted the suggestion of one commenter that 
the exemption require the Financial

[[Page 21112]]

Institution to designate a specific person to address Material 
Conflicts of Interest and monitor Advisers' adherence to the Impartial 
Conduct Standards.\39\ In the proposal, the Department had already 
suggested that Financial Institutions consider this approach; however, 
the commenter suggested that it should be a specific requirement and 
indicated that most Financial Institutions already have a designated 
compliance officer. The Department concurs with the commenter and has 
included that requirement in the final exemption, based on the view 
that formalizing the process for identifying and monitoring these 
issues will result in increased protections to Retirement Investors.
---------------------------------------------------------------------------

    \39\ One important consideration in addressing conflicts of 
interest is the Financial Institution's attentiveness to the 
qualifications and disciplinary history of the persons it employs to 
provide such advice. See Egan, Mark, Gregor Matvos and Amit Seru, 
The Market for Financial Adviser Misconduct, at 3 (February 26, 
2016) (``Past offenders are five times more likely to engage in 
misconduct than the average adviser, even compared with other 
advisers in the same firm at the same point in time. The large 
presence of repeat offenders suggests that consumers could avoid a 
substantial amount of misconduct by avoiding advisers with 
misconduct records.'').
---------------------------------------------------------------------------

b. Specific Language of Policies and Procedures Requirement
    There were also questions and comments on certain language in the 
proposed policies and procedures requirement. As proposed, the 
components of the policies and procedures requirement in Section II(d) 
read as follows:

     The Financial Institution has adopted written policies 
and procedures reasonably designed to mitigate the impact of 
Material Conflicts of Interest and to ensure that its individual 
Advisers adhere to the Impartial Conduct Standards set forth in 
Section II(c);
     In formulating its policies and procedures, the 
Financial Institution has specifically identified Material Conflicts 
of Interest and adopted measures to prevent the Material Conflicts 
of Interest from causing violations of the Impartial Conduct 
Standards set forth in Section II(c); and
     Neither the Financial Institution nor (to the best of 
its knowledge) any Affiliate uses quotas, appraisals, performance or 
personnel actions, bonuses, contests, special awards, differential 
compensation or other actions or incentives to the extent they would 
tend to encourage individual Advisers to make recommendations 
regarding principal transactions that are not in the Best Interest 
of the Retirement Investor.

    A few commenters asked the Department to explain the difference 
between the first and second prongs of the policies and procedures 
requirement, as proposed. In response, the first prong of the 
requirement was intended to establish a general standard, while the 
second (and third) prongs provided specific rules regarding the 
policies and procedures requirement. This approach was also adopted in 
the final exemption. In addition, the language of Section II(d)(3) 
specifically provides that the third prong of the requirement, 
requiring Financial Institutions to insulate Advisers from incentives 
to violate the Best Interest standard, is part of the policies and 
procedures requirement.
    There were also comments on (i) the definition and use of the term 
``Material Conflicts of Interest;'' (ii) the language requiring the 
policies and procedures to be ``reasonably designed'' to mitigate the 
impact of such conflicts of interest, and (iii) the meaning of 
incentives that ``tend to encourage'' individual Advisers to make 
recommendations that are not in the Best Interest of the Retirement 
Investor. These comments are discussed below.
i. Materiality
    A number of commenters focused on the definition of Material 
Conflict of Interest used in the proposal. Under the definition as 
proposed, a Material Conflict of Interest exists when an Adviser or 
Financial Institution ``has a financial interest that could affect the 
exercise of its best judgment as a fiduciary in rendering advice to a 
Retirement Investor.'' Some commenters took the position that the 
proposal did not adequately explain the term ``material'' or 
incorporate a materiality standard into the definition. A commenter 
wrote that the proposed definition was so broad that it would be 
difficult for Financial Institutions to comply with the various aspects 
of the exemption related to Material Conflicts of Interest, such as 
provisions requiring disclosure of Material Conflicts of Interest.
    Another commenter indicated that the Department should not use the 
term ``material'' in defining conflicts of interest. The commenter 
believed that it could result in a standard that was too subjective 
from the perspective of the Adviser and Financial Institution, and 
could undermine the protectiveness of the exemption.
    After consideration of the comments, the Department adjusted the 
definition of Material Conflict of Interest. In the final exemption, a 
Material Conflict of Interest exists when an Adviser or Financial 
Institution has a ``financial interest that that a reasonable person 
would conclude could affect the exercise of its best judgment as a 
fiduciary in rendering advice to a Retirement Investor.'' This language 
responds to concerns about the breadth and potential subjectivity of 
the standard. The Department did not, as some commenters suggested, 
include the word ``material'' in the definition of Material Conflict of 
Interest, to avoid the potential circularity of that approach.
ii. Reasonably Designed
    One commenter asked that the Department more broadly use the 
modifier ``reasonably designed'' in describing the standard the 
policies and procedures must meet so as to avoid a construction that 
required standards that ensured perfect compliance, a potentially 
unattainable standard. The Department has accepted the comment and 
adjusted the language in Sections II(d)(1) and (2) to generally use the 
phrase ``reasonably and prudently designed.'' Other commenters asked 
for guidance on the proposed phrasing ``reasonably designed to 
mitigate'' the impact of Material Conflicts of Interest. The Department 
provides additional guidance in this respect in the preamble of the 
Best Interest Contract Exemption published elsewhere in this issue of 
the Federal Register, which gives examples of some possible approaches 
to policies and procedures.
iii. Tend To Encourage
    A number of commenters asked for clarification or revision of the 
proposed exemption's prohibition of incentives that ``tend to 
encourage'' violation of the Best Interest standard, generally to 
require a tight link between the incentives and the Advisers' 
recommendations. Commenters argued that the ``tend to encourage'' 
language established a standard that could be impossible to meet in the 
context of differential compensation. Accordingly, they requested that 
the Department use language such as ``intended to encourage,'' ``does 
encourage,'' ``causes,'' or similar formulation.
    In response to these commenters the Department has adjusted the 
condition's language as follows:

    [N]either the Financial Institution nor (to the best of the 
Financial Institution's knowledge) any Affiliate uses or relies on 
quotas, appraisals, performance or personnel actions, bonuses, 
contests, special awards, differential compensation or other actions 
or incentives that are intended or would reasonably be expected to 
cause individual Advisers to make recommendations regarding 
Principal Transactions and Riskless Principal Transactions that are 
not in the Best Interest of the Retirement Investor (emphasis 
added).

    This language more accurately captures the Department's intent, 
which was to require that procedures reasonably address Advisers' 
incentives,

[[Page 21113]]

not guarantee perfection. The Department disagrees, however, with the 
suggestion that Financial Institutions should be permitted to tolerate 
or create incentives that would ``reasonably be expected to cause such 
violations'' unless the Retirement Investor can actually prove the 
Financial Institution's intent to cause violations of the standard or 
the Adviser's improper motivation in making the recommendation. The aim 
of the policies and procedures requirement is to require the Financial 
Institution to take prophylactic measures to ensure that Retirement 
Advisers adhere to the Impartial Conduct Standards, a goal completely 
at odds with the creation of incentives to violate the Best Interest 
standard. In exchange for the receipt of compensation that would 
otherwise be prohibited by ERISA and the Code, the Financial 
Institution's responsibility under the exemption is to protect 
Retirement Investors from conflicts of interest, not to promote or 
continue to offer incentives to violate the Best Interest standard. 
Moreover, absent extensive discovery or the ability to prove the 
motivations of individual Advisers, Retirement Investors would 
generally be in a poor position to prove such ill intent.
    However, the final exemption provides that the policies and 
procedures requirement does not:

    [P]revent the Financial Institution or its Affiliates from 
providing Advisers with differential compensation (whether in type 
or amount, and including, but not limited to, commissions) based on 
investment decisions by Plans, participant or beneficiary accounts, 
or IRAs, to the extent that the policies and procedures and 
incentive practices, when viewed as a whole, are reasonably and 
prudently designed to avoid a misalignment of the interests of 
Advisers with the interests of the Retirement Investors they serve 
as fiduciaries (emphasis added).

    This language is designed to make clear that differential 
compensation is permitted, but only if the Financial Institution's 
policies and procedures, as a whole, are reasonably designed to avoid a 
misalignment of interests between Advisers and Retirement Investors.
    For further guidance, the preamble to the Best Interest Contract 
Exemption, published in this same issue of the Federal Register, 
provides examples of the types of policies and procedures that may 
satisfy the warranty.
c. Contractual Warranty Versus Exemption Condition
    In the proposal, both the Adviser and Financial Institution had to 
give a warranty to the Retirement Investor about the adoption and 
implementation of anti-conflict policies and procedures. A few 
commenters indicated that the Adviser should not be required to give 
the warranty, and questioned whether the Adviser would always be in a 
position to speak to the Financial Institution's incentive and 
compensation arrangements. The Department agrees that the Financial 
Institution has the primary responsibility for design and 
implementation of the policies and procedures requirement and, 
accordingly, has limited the warranty requirement to the Financial 
Institution.
    Some commenters believed that even if the Department included a 
policies and procedure requirement in the exemption, it should not 
require a warranty on implementation and compliance with the 
requirement. According to some of these commenters the warranty was 
unnecessary in light of the Best Interest standard, and would unduly 
contribute to litigation risk. A few commenters also suggested that a 
Financial Institution's failure to comply with the contractual warranty 
could give rise to a cause of action to Retirement Investors who had 
suffered no injuries from failure to implement or comply with 
appropriate policies and procedures. A few other commenters expressed 
concern that the provision of a warranty could result in tort 
liability, rather than just contractual liability.
    Other commenters argued that the Department should require 
Financial Institutions not only to make an enforceable warranty as a 
condition of the exemption, but also require actual compliance with the 
warranty as a condition of the exemption. One such commenter argued 
that it would be difficult for Retirement Investors to prove that 
policies and procedures were not ``reasonably designed'' to achieve the 
required purpose.
    As noted above, the final exemption adopts the required policies 
and procedures as a condition of the exemption. The policies and 
procedures requirement is a critical part of the exemption's 
protections. The risk of liability associated with a non-exempt 
prohibited transaction gives Financial Institutions a strong incentive 
to design protective policies and procedures in a way that is 
consistent with the purposes and requirements of this exemption. Of 
course, the Department does not expect that successful contract claims 
will be brought by Retirement Investors without a showing of damages.
    In addition, the final exemption requires the Financial Institution 
to make a warranty regarding the policies and procedures in contracts 
with Retirement Investors regarding IRAs and other non-ERISA plans. The 
warranty, and potential liability associated with that warranty, gives 
Financial Institutions both the obligation and the incentive to tamp 
down harmful conflicts of interest and protect Retirement Investors 
from misaligned incentives that encourage Advisers to violate the Best 
Interest standard and other fiduciary obligations and ensures that 
there is a means to redress the failure to do so. While the warranty 
exposes Financial Institutions and Advisers to litigation risk, these 
risks are circumscribed by the availability of binding arbitration for 
individual claims and the legal restrictions that courts generally use 
to police class actions.
    The Department does not share a commenter's view that it would be 
too difficult for Retirement Investors to prove that the policies and 
procedures were not ``reasonably designed'' to achieve the required 
purpose. The final exemption requires the Financial Institution to 
disclose Material Conflicts of Interest associated with the principal 
transactions and riskless principal transactions to Retirement 
Investors and to describe its policies and procedures for safeguarding 
against those conflicts of interest. These disclosures should assist 
Retirement Investors in assessing the care with which Financial 
Institutions have designed their procedures, even if they are 
insufficient to fully convey how vigorously the Financial Institution 
implements the protections. In some cases, a systemic violation, or the 
possibility of such a violation, may be apparent on the face of the 
policies. In other cases, normal discovery in litigation may provide 
the information necessary. Certainly, if a Financial Institution were 
to provide significant prizes or bonuses for Advisers to push principal 
transactions and riskless principal transactions that were not in the 
Best Interest of Retirement Investors, Retirement Investors would often 
be in a position to pursue the claim. Most important, however, the 
enforceable obligation to adopt and comply with the policies and 
procedures as set forth herein, and to make relevant disclosures of the 
policies and procedures and of Material Conflicts of Interest, should 
create a powerful incentive for Financial Institutions to carefully 
police conflicts of interest, reducing the need for litigation in the 
first place.
    In response to commenters that expressed concern about the specific 
use of the term ``warranty,'' the Department intends the term to have 
its standard meaning as a ``promise that something in furtherance of 
the contract

[[Page 21114]]

is guaranteed by one of the contracting parties.'' \40\ The Department 
merely requires that the contract with IRA and non-ERISA plan investors 
include an express enforceable promise of compliance with the policies 
and procedures condition. As previously discussed, the potential 
liability for violation of the warranty is cabined by the availability 
of non-binding arbitration in individual claims, and the ability to 
waive claims for punitive damages and rescission to the extent 
permitted by applicable law.
---------------------------------------------------------------------------

    \40\ Black's Law Dictionary 10th ed. (2014).
---------------------------------------------------------------------------

    Additionally, although the policies and procedure requirement 
applies equally to ERISA plans, the final exemption does not require 
Financial Institutions to make a warranty with respect to ERISA plans, 
just as it does not require the execution of a contract with respect to 
ERISA plans. For these plans, a separate warranty is unnecessary 
because Title I of ERISA already provides an enforcement mechanism for 
failure to comply with the policies and procedures requirement. Under 
ERISA section 502(a), plan participants, fiduciaries, and the Secretary 
of Labor have ready means to enforce any failure to meet the conditions 
of the exemption, including a failure to comply with the policies and 
procedure requirement. A Financial Institution's failure to comply with 
the exemption's policies and procedure requirements would result in a 
non-exempt prohibited transaction under ERISA section 406 and would 
likely constitute a fiduciary breach under ERISA section 404. As a 
result, a plan participant or beneficiary, plan fiduciary, and the 
Secretary would be able to sue under ERISA section 502(a)(2), (3), or 
(5) to recover any loss in value to the plan (including the loss in 
value to an individual account), or to obtain disgorgement of any 
wrongful profits or unjust enrichment. Accordingly, the warranty is 
unnecessary in the context of ERISA plans.
d. Compliance With Laws Proposed Warranty
    The proposed exemption also contained a requirement that the 
Adviser and Financial Institution would have had to warrant that they 
and their Affiliates would comply with all applicable federal and state 
laws regarding the rendering of the investment advice, the purchase, 
sale or holding of the Asset and the payment of compensation related to 
the purchase, sale and holding. While the Department did receive some 
support for this condition in comments, several commenters opposed this 
warranty proposal as being overly broad, and urged that it be deleted. 
The commenters argued that the warranty could create contract claims 
based on a wide variety of state and federal laws, without regard to 
the limitations imposed on individual actions under those laws. In 
addition, commenters suggested that many of the violations associated 
with these laws could be quite minor or unrelated to the Department's 
concerns about conflicts of interest. In response to these comments, 
the Department has eliminated this warranty from the final exemption.
6. Credit Standards and Liquidity
    Section II(d)(4) provides that the Financial Institution's written 
policies and procedures regarding principal transactions and riskless 
principal transactions must address how the credit risk and liquidity 
assessments required by Section III(a)(3) of the exemption will be 
made. This requirement serves as an implementation tool for the 
exemption condition that a debt security that is purchased by a plan, 
participant or beneficiary account, or IRA, possess at the time of 
purchase no greater than moderate credit risk and sufficiently 
liquidity that it can be sold at or near its carrying value within a 
reasonably short period of time.
    As discussed later in this preamble, when addressing the credit and 
liquidity conditions set forth in Section III(a) of the exemption, many 
commenters identified perceived compliance difficulties. Of those 
comments, one comment was applicable to Section II of the exemption. 
The commenter suggested that the Financial Institution be required to 
develop policies and procedures to assist Advisers by specifying how 
these assessments are to be made. This suggestion addressed some 
concerns expressed by commenters regarding the credit and liquidity 
conditions, and the Department concurs with the comment. The Department 
believes that Financial Institutions will be able to comply with the 
requirement, in part, by developing, if they do not already exist, 
policies and procedures to ensure that the credit worthiness and 
liquidity of debt securities are properly evaluated.
7. Contractual Disclosures
    Section II(e) of the exemption obligates the Financial Institution 
to make specified contract disclosures to Retirement Investors in order 
to ensure that they have basic information about the scope of Adviser 
conflicts and that they appropriately authorize principal transactions 
and riskless principal transactions. For advice to Retirement Investors 
in IRAs and non-ERISA plans, the disclosures must be provided prior to 
or at the same time as the recommended transaction either as part of 
the contract or in a separate written disclosure provided to the 
Retirement Investor. For advice to Retirement Investors regarding 
investments in ERISA plans, the disclosures must be provided prior to 
or at the same time as the execution of the recommended transaction. 
The disclosure may be provided in person, electronically, or by mail. 
In the disclosures, the Financial Institution must clearly and 
prominently in a single written disclosure:

    (1) Set forth in writing (i) the circumstances under which the 
Adviser and Financial Institution may engage in Principal 
Transactions and Riskless Principal Transactions with the Plan, 
participant or beneficiary account, or IRA, (ii) a description of 
the types of compensation that may be received by the Adviser and 
Financial Institution in connection with Principal Transactions and 
Riskless Principal Transactions, including any types of compensation 
that may be received from third parties, and (iii) identify and 
disclose the Material Conflicts of Interest associated with 
Principal Transactions and Riskless Principal Transactions;
    (2) Except for existing contracts, document the Retirement 
Investor's affirmative written consent, on a prospective basis, to 
Principal Transactions and Riskless Principal Transactions between 
the Adviser or Financial Institution and the Plan, participant or 
beneficiary account, or IRA;
    (3) Inform the Retirement Investor (i) that the consent set 
forth in Section II(e)(2) is terminable at will upon written notice 
by the Retirement Investor at any time, without penalty to the Plan 
or IRA, (ii) of the right to obtain, free of charge, copies of the 
Financial Institution's written description of its policies and 
procedures adopted in accordance with Section II(d), as well as 
information about the Principal Traded Asset, including its purchase 
or sales price, and other salient attributes, including, as 
applicable: The credit quality of the issuer; the effective yield; 
the call provisions; and the duration, provided that if the 
Retirement Investor's request is made prior to the transaction, the 
information must be provided prior to the transaction, and if the 
request is made after the transaction, the information must be 
provided within 30 business days after the request, (iii) that model 
contract disclosures or other model notice of the contractual terms 
which are reviewed for accuracy no less than quarterly and updated 
within 30 days as necessary are maintained on the Financial 
Institution's Web site, and (iv) that the Financial Institution's 
written description of its policies and procedures adopted in

[[Page 21115]]

accordance with Section II(d) is available free of charge on the 
Financial Institution's Web site; and
    (4) Describe whether or not the Adviser and Financial 
Institution will monitor the Retirement Investor's investments that 
are acquired through a Principal Transaction or Riskless Principal 
Transaction and alert the Retirement Investor to any recommended 
change to those investments and, if so, the frequency with which the 
monitoring will occur and the reasons for which the Retirement 
Investor will be alerted.

By ``clearly and prominently in a single written disclosure,'' the 
Department means that the Financial Institution may provide a document 
prepared for this purpose containing only the required information, or 
include the information in a specific section of the contract in which 
the disclosure information is provided, rather than requiring the 
Retirement Investor to locate the relevant information in several 
places throughout a larger disclosure or series of disclosures.

    In addition, Section II(e)(5) of the exemption provides a mechanism 
for correcting disclosure errors, without losing the exemption. It 
provides that the Financial Institution will not fail to satisfy 
Section II(e), or violate a contractual provision based thereon, solely 
because it, acting in good faith and with reasonable diligence, makes 
an error or omission in disclosing the required information, or if the 
Web site is temporarily inaccessible, provided that (i) in the case of 
an error or omission on the web, the Financial Institution discloses 
the correct information as soon as practicable, but not later than 7 
days after the date on which it discovers or reasonably should have 
discovered the error or omission, and (ii) in the case of other 
disclosures, the Financial Institution discloses the correct 
information as soon as practicable, but not later than 30 days after 
the date on which it discovers or reasonably should have discovered the 
error or omission. Section II(e)(5) further provides that to the extent 
compliance with the contract disclosure requires Advisers and Financial 
Institutions to obtain information from entities that are not closely 
affiliated with them, they may rely in good faith on information and 
assurances from the other entities, as long as they do not know that 
the materials are incomplete or inaccurate. This good faith reliance 
applies unless the entity providing the information to the Adviser and 
Financial Institution is (1) a person directly or indirectly through 
one or more intermediaries, controlling, controlled by, or under common 
control with the Adviser or Financial Institution; or (2) any officer, 
director, employee, agent, registered representative, relative (as 
defined in ERISA section 3(15)), member of family (as defined in Code 
section 4975(e)(6)) of, or partner in, the Adviser or Financial 
Institution.
    Several commenters supported the proposed disclosures. Commenters 
recognized that well-designed disclosure can serve multiple purposes, 
including facilitating informed investment decisions. However, even if 
investors do not carefully review the disclosures they receive, 
commenters perceived a benefit to investors from the greater 
transparency of public disclosure. For example, Financial Institutions 
may change practices that run contrary to Retirement Investors' 
interests rather than disclose them publicly. One commenter suggested 
the disclosures should be strengthened and required for all retirement 
savings products, even beyond the scope of the Regulation and this 
exemption.
    As proposed, the provision required disclosure of complete 
information about all the fees and other payments currently associated 
with the Retirement Investor's investments. Commenters objected to this 
as overly broad, given the exemption's limitation to principal 
transactions. The Department accepted this comment, and limited the 
disclosure to the information about the principal traded asset, 
including its purchase or sales price and other salient attributes, 
while still ensuring timely access by the Retirement Investor. By 
salient attributes, the Department means the credit quality of the 
issuer, the effective yield, the call provisions, and the duration, 
among other similar attributes, and the Department recognizes that the 
salient attributes will differ depending on the principal traded asset. 
In accepting this comment, the Department did not elect to modify the 
disclosure requirement further with qualifiers such as ``reasonably'' 
or ``in the Financial Institution's possession.'' The Department 
believes that no additional limitation need be placed on the rights of 
the Retirement Investor to request information because, if a Financial 
Institution is advising a Retirement Investor to enter into a principal 
transaction or a riskless principal transaction, it should have all of 
the salient information available when providing that advice. The 
Department also made a clarification, requested by a commenter, that 
the Retirement Investor's consent must be withdrawn in writing. The 
Department concurs that this will provide additional certainty to the 
parties.
    FINRA's suggestion that the parties agree on the extent of 
monitoring of the Retirement Investor's investments was adopted, in 
Section II(e)(4). In making this determination, Financial Institutions 
should carefully consider whether certain investments can be prudently 
recommended to the individual Retirement Investor, in the first place, 
without a mechanism in place for the ongoing monitoring of the 
investment. Finally, a number of commenters requested relief for good 
faith, inadvertent failure to comply with the exemption. A specific 
provision applicable to the Section II(e) disclosures is included in 
Section II(e)(5).
8. Ineligible Provisions
    Under Section II(f) of the final exemption, relief is not available 
if a Financial Institution's contract with Retirement Investors 
regarding investments in IRAs and non-ERISA plans contains the 
following:

    (1) Exculpatory provisions disclaiming or otherwise limiting 
liability of the Adviser or Financial Institution for a violation of 
the contract's terms;
    (2) Except as provided in paragraph (f)(4), a provision under 
which the Plan, IRA or Retirement Investor waives or qualifies its 
right to bring or participate in a class action or other 
representative action in court in a dispute with the Adviser or 
Financial Institution, or in an individual or class claim agrees to 
an amount representing liquidated damages for breach of the 
contract; provided that the parties may knowingly agree to waive the 
Retirement Investor's right to obtain punitive damages or rescission 
of recommended transactions to the extent such a waiver is 
permissible under applicable state or federal law; or
    (3) Agreements to arbitrate or mediate individual claims in 
venues that are distant or that otherwise unreasonably limit the 
ability of the Retirement Investors to assert the claims safeguarded 
by this exemption.

    Section II(f)(4) provides that, in the event the provision on pre-
dispute arbitration agreements for class or representative claims in 
paragraph (f)(2) is ruled invalid by a court of competent jurisdiction, 
this provision shall not be a condition of the exemption with respect 
to contracts subject to the court's jurisdiction unless and until the 
court's decision is reversed, but all other terms of the exemption 
shall remain in effect.
    The purpose of Section II(f) is to ensure that Retirement Investors 
receive the full benefit of the exemption's protections, by preventing 
them from being contracted away. If an Adviser makes a recommendation 
regarding a principal transaction or a riskless principal transaction, 
for compensation, within the meaning of the Regulation, he or she may 
not disclaim the duties or liabilities that flow from that

[[Page 21116]]

recommendation. For similar reasons, the exemption is not available if 
the contract includes provisions that purport to waive a Retirement 
Investor's right to bring or participate in class actions. However, 
contract provisions in which Retirement Investors agree to arbitrate 
any individual disputes are allowed to the extent permitted by 
applicable state law. Moreover, Section II(f) does not prevent 
Retirement Investors from voluntarily agreeing to arbitrate class or 
representative claims after the dispute has arisen.
    The Department's approach in this respect is consistent with 
FINRA's rules permitting mandatory pre-dispute arbitration for 
individual claims, but not for class action claims.\41\ This rule was 
adopted in 1992, in response to a directive, articulated by former SEC 
Chairman David Ruder, that investors have access to courts in 
appropriate cases.\42\ Section 12000 of the FINRA manual establishes a 
Code of Arbitration Procedure for Customer Disputes which sets forth 
rules on, inter alia, filing claims, amending pleadings, prehearing 
conferences, discovery, and sanctions for improper behavior.
---------------------------------------------------------------------------

    \41\ FINRA rule 12204(a) provides that class actions may not be 
arbitrated under the FINRA Code of Arbitration Procedures. FINRA 
rule 2268(d)(3) provides that no predispute arbitration agreement 
may limit the ability of a party to file any claim in court 
permitted to be filed in court under the rules of the forums in 
which a claim may be filed under the agreement. The FINRA Board of 
Governors has ruled that a broker's predispute arbitration agreement 
with a customer may not include a waiver of the right to file or 
participate in a class action in court. Department of Enforcement v. 
Charles Schwab & Co. (Complaint 2011029760201) (Apr. 24, 2014).
    \42\ NASD Notice 92-65 SEC Approval of Amendments Concerning the 
Exclusion of Class-Action Matters from Arbitration Proceedings and 
Requiring that Predispute Arbitration Agreements Include a Notice 
That Class-Action Matters May Not Be Arbitrated, available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=1660.
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    A number of commenters addressed the proposed approach to 
arbitration and the other ineligible provisions of Section II(f). A 
discussion of the comments and the Department's responses follow.
a. Exculpatory Provisions
    The Department included Section II(f)(1) in the final exemption 
without changes from the proposal. Commenters did, however, raise a few 
questions on the provision. In particular, commenters asked whether the 
contract could disclaim liability for acts or omissions of third 
parties, and whether there could be venue selection clauses. In 
addition, commenters asked whether the contract could require 
exhaustion of arbitration or mediation before filing in court. Section 
II(f)(1) does not prevent a Financial Institution's contract with IRA 
and non-ERISA plan investors from disclaiming liability for acts or 
omissions of third parties to the extent permissible under applicable 
law. In addition, for individual claims, reasonable arbitration and 
mediation requirements are not prohibited. In response to questions 
about venue selection, the final exemption includes a new Section 
II(f)(3), which provides that investors may not be required to 
arbitrate or mediate their individual claims in venues that are distant 
or that otherwise unreasonably limit their ability to assert the claims 
safeguarded by this exemption.
    The Department has not revised Section II(f) to address every 
provision that may or may not be included in the contract. While some 
commenters submitted specific requests regarding specific contract 
language, and others suggested the Department provide model contracts 
for Financial Institutions to use, the Department has declined to make 
these changes in the exemption. The Department notes that Section 
II(f)(1) prohibits all exculpatory provisions disclaiming or otherwise 
limiting liability of the Adviser or Financial Institution for a 
violation of the contract's terms, and Section II(g)(5) prohibits 
Financial Institutions and Advisers from purporting to disclaim any 
responsibility or liability for any responsibility, obligation, or duty 
under Title I of ERISA to the extent the disclaimer would be prohibited 
by Section 410 of ERISA. Therefore, in response to comments regarding 
choice of law provisions, modifying ERISA's statute of limitations, and 
imposing obligations on the Retirement Investor, the Financial 
Institutions must determine whether their specific provisions are 
exculpatory and would disclaim or limit their liability under ERISA, or 
that of their Advisers. If so, they are not permitted. The Department 
will provide additional guidance in response to questions and 
enforcement proceedings
b. Arbitration
    Section II(f)(2) of the final exemption adopts the approach, as 
proposed, that individual claims may be the subject of contractual pre-
dispute binding arbitration. Class or other representative claims, 
however, must be allowed to proceed in court. The final exemption also 
provides that contract provisions may not limit recoveries to an amount 
representing liquidated damages for breach of the contract. However, 
the final exemption expressly permits Retirement Investors to knowingly 
waive their rights to obtain punitive damages or rescission of 
recommended transactions to the extent such waivers are permitted under 
applicable law. Commenters were divided on the approach taken in the 
proposal, as discussed below.
    Some commenters objected to limiting Retirement Investors' right to 
sue in court on individual claims and specifically focused on the FINRA 
arbitration process. These commenters described FINRA's process as an 
unequal playing field, with insufficient protections for individual 
investors. They asserted that arbitrators are not required to follow 
federal or state laws, and so would not be required to enforce the 
terms of the contract. In addition, commenters complained that the 
decision of an arbitrator generally is not subject to appeal and cannot 
be overturned by any court. According to these commenters, even when 
the arbitrators find in favor of the consumer, the consumers often 
receive significantly smaller recoveries than they deserve. Moreover, 
some asserted that binding pre-dispute arbitration may be contrary to 
the legislative intent of ERISA, which provides for ``ready access to 
federal courts.''
    Some commenters opposed to arbitration indicated that preserving 
the right to bring or participate in class actions in court would not 
give Retirement Investors sufficient access to courts. According to 
these commenters, allowing Financial Institutions to require resolution 
of individual claims by arbitration would impose additional and 
unnecessary hurdles on investors seeking to enforce the Best Interest 
standard. One commenter warned that the Regulation would make it more 
difficult for Retirement Investors to pursue class actions because the 
individualized requirements for proving fiduciary status could 
undermine any claims about commonality. Commenters said that class 
action lawsuits tend to be expensive and protracted, and even where 
successful, investors often recover only a small portion of their 
losses.
    Other commenters just as forcefully supported pre-dispute binding 
arbitration agreements. Some asserted that arbitration is generally 
quicker and less costly than judicial proceedings. They argued that 
FINRA has well-developed protections in place to protect the interests 
of aggrieved investors. One commenter pointed out that FINRA requires 
that the arbitration provisions of a contract be highlighted and 
disclosed to the customer, and that customers be allowed to choose an 
``all-

[[Page 21117]]

public'' panel of arbitrators.\43\ FINRA rules also impose larger 
filing fees on the industry party than on the investor. Commenters also 
cited evidence that investors are as likely to prevail in arbitration 
proceedings as they are in court, and even argued that permitting 
mandatory arbitration for all disputes would be in investors' best 
interest.
---------------------------------------------------------------------------

    \43\ The term ``Public Arbitrator'' is defined in FINRA rule 
12100(u). According to FINRA, non-``Public Arbitrators'' are often 
referred to as ``industry'' arbitrators. See Final Report and 
Recommendations of the FINRA Dispute Resolution Task Force, released 
December 16, 2015.
---------------------------------------------------------------------------

    A number of commenters argued that arbitration should be available 
for all disputes that may arise under the exemption, including class or 
representative claims. Some of these commenters favored arbitration of 
class claims due to concerns about costs and potentially greater 
liability associated with class actions brought in court. Some 
commenters took the position that the ability of the Retirement 
Investor to participate in class actions could deter Financial 
Institutions from relying on the exemption at all.
    After consideration of the comments on this subject, the Department 
has decided to adopt the general approach taken in the proposal. 
Accordingly, contracts with Retirement Investors may require pre-
dispute binding arbitration of individual disputes with the Adviser or 
Financial Institution. The contract, however, must preserve the 
Retirement Investor's right to bring or participate in a class action 
or other representative action in court in such a dispute in order for 
the exemption to apply.
    The Department recognizes that, for many claims, arbitration can be 
more cost-effective than litigation in court. Moreover, the exemption's 
requirement that Financial Institutions acknowledge their own and their 
Advisers' fiduciary status should eliminate an issue that frequently 
arises in disputes over investment advice. In addition, permitting 
individual matters to be resolved through arbitration tempers the 
litigation risk and expense for Financial Institutions, without 
sacrificing Retirement Investors' ability to secure judicial relief for 
systemic violations that affect numerous investors through class 
actions.
    On the other hand, the option to pursue class actions in court is 
an important enforcement mechanism for Retirement Investors. Class 
actions address systemic violations affecting many different investors. 
Often the monetary effect on a particular investor is too small to 
justify the pursuit of an individual claim, even in arbitration. 
Exposure to class claims creates a powerful incentive for Financial 
Institutions to carefully supervise individual Advisers, and ensure 
adherence to the Impartial Conduct Standards. This incentive is 
enhanced by the transparent and public nature of class proceedings and 
judicial opinions, as opposed to arbitration decisions, which are less 
visible and pose less reputational risk to Financial Institutions or 
Advisers found to have violated their obligations.
    The ability to bar investors from bringing or participating in such 
claims would undermine important investor rights and incentives for 
Advisers to act in accordance with the Best Interest standard. As one 
commenter asserted, courts impose significant hurdles for bringing 
class actions, but where investors can surmount theses hurdles, class 
actions are particularly well suited for addressing systemic breaches. 
Although by definition communications to a specific investor generally 
must have a degree of specificity in order to constitute fiduciary 
advice, a class of investors should be able to satisfy the requirements 
of commonality, typicality and numerosity where there is a systemic or 
wide-spread problem, such as the adoption or implementation of non-
compliant policies and procedures applicable to numerous Retirement 
Investors, the systematic use of prohibited or misaligned financial 
incentives, or other violations affecting numerous Retirement Investors 
in a similar way. Moreover, the judicial system ensures that disputes 
involving numerous retirement investors and systemic issues will be 
resolved through a well-established framework characterized by 
impartiality, transparency, and adherence to precedent. The results and 
reasoning of court decisions serve as a guide for the consistent 
application of that law in future cases involving other Retirement 
Investors and Financial Institutions.
    This is consistent with the approach long adopted by FINRA and its 
predecessor self-regulatory organizations. FINRA Arbitration rule 12204 
specifically bars class actions from FINRA's arbitration process and 
requires that pre-dispute arbitration agreements between brokers and 
customers contain a notice that class action matters may not be 
arbitrated. In addition, it provides that a broker may not enforce any 
arbitration agreement against a member of certified or putative class 
action, until the certification is denied, the class action is 
decertified, the class member is excluded from, or elects not 
participate in, the class. This rule was adopted by the National 
Association of Securities Dealers and approved by the SEC in 1992.\44\ 
In the release announcing this decision, the SEC stated:
---------------------------------------------------------------------------

    \44\ SEC Release No. 34-31371 (Oct. 28, 1992), 1992 WL 324491.

    [T]he NASD believes, and the Commission agrees, that the 
judicial system has already developed the procedures to manage class 
action claims. Entertaining such claims through arbitration at the 
NASD would be difficult, duplicative and wasteful. . . . The 
Commission agrees with the NASD's position that, in all cases, class 
actions are better handled by the courts and that investors should 
have access to the courts to resolve class actions efficiently.\45\
---------------------------------------------------------------------------

    \45\ Id.

In 2014, the FINRA Board of Governors upheld this rule in reviewing an 
enforcement action.\46\
---------------------------------------------------------------------------

    \46\ FINRA Decision, Department of Enforcement v. Charles Schwab 
& Co. (Complaint 2011029760201), p.14 (Apr. 24, 2014).
---------------------------------------------------------------------------

Additional Protections
    One commenter suggested that if the Department preserved the 
ability of a Financial Institution to require arbitration of claims, it 
should consider requiring a series of additional safeguards for 
arbitration proceedings permitted under the exemption. The commenter 
suggested that the conditions could state that (i) the arbitrator must 
be qualified and independent; (ii) the arbitration must be held in the 
location of the person challenging the action; (iii) the cost of the 
arbitration must be borne by the Financial Institution; (iv) the 
Financial Institution's attorneys' fees may not be shifted to the 
Retirement Investor, even if the challenge is unsuccessful; (v) 
statutory remedies may not be limited or altered by the contract; (vi) 
access to adequate discovery must be permitted; (vii) there must be a 
written record and a written decision; (viii) confidentiality 
requirements and protective orders which would prohibit the use of 
evidence in subsequent cases must be prohibited. The commenter said 
that some, but not all, of these procedures are currently required by 
FINRA.
    The Department declines to mandate additional procedural safeguards 
for arbitration beyond those already mandated by other applicable 
federal and state law or self-regulatory organizations. In the 
Department's view, the FINRA arbitration rules, in particular, provide 
significant safeguards for fair dispute resolution, notwithstanding the 
concerns raised by some commenters. FINRA's Code of Arbitration 
Procedures for Customer Disputes applies when required by written 
agreement between the FINRA member and the customer, or if the

[[Page 21118]]

customer requests arbitration. The rules cover any dispute between the 
member and the customer that arises from the member's business 
activities, except for disputes involving insurance business activities 
of a member that is an insurance company.\47\ FINRA's code of 
procedures also provide detailed instructions for initiating and 
pursuing an arbitration, including rules for selection of arbitrators 
(FINRA rule 12400), for discovery of evidence (FINRA rule 12505), and 
expungement of customer dispute information (FINRA rule 12805), which 
are designed to allow access by investors and preserve fairness for the 
parties. In addition, FINRA rule 12213 specifies that FINRA will 
generally select the hearing location closest to the customer. To the 
extent that the contracts provide for binding arbitration in individual 
claims, the Department defers to the judgment of FINRA and other 
regulatory bodies, such as state insurance regulators, responsible for 
determining the safeguards applicable to arbitration proceedings.
---------------------------------------------------------------------------

    \47\ FINRA rule 12200.
---------------------------------------------------------------------------

Federal Arbitration Act
    Some commenters asserted that the Department does not have the 
authority to include the exemption's provisions on class action waivers 
under the Federal Arbitration Act (FAA), which they said protects 
enforceable arbitration agreements and expresses a federal policy in 
favor of arbitration over litigation. Without clear statutory authority 
to restrict arbitration, these commenters said, the Department cannot 
include the provisions on class action waivers.
    These comments misconstrue the effect of the FAA on the 
Department's authority to grant exemptions from prohibited 
transactions. The FAA protects the validity and enforceability of 
arbitration agreements. Section 2 of the FAA states: ``[a] written 
provision in any . . . contract . . . to settle by arbitration a 
controversy thereafter arising out of such contract . . . shall be 
valid, irrevocable, and enforceable, save upon such grounds as exist at 
law or in equity for the revocation of any contract.'' \48\ This Act 
was intended to reverse judicial hostility to arbitration and to put 
arbitration agreements on an equal footing with other contracts.\49\
---------------------------------------------------------------------------

    \48\ 9 U.S.C. 2.
    \49\ See AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 342 
(2011).
---------------------------------------------------------------------------

    Section II(f)(2) of the exemption is fully consistent with the FAA. 
The exemption does not purport to render an arbitration provision in a 
contract between a Financial Institution and a Retirement Investor 
invalid, revocable, or unenforceable. Nor, contrary to the concerns of 
one commenter, does Section II(f)(2) prohibit such waivers. Both 
Institutions and Advisers remain free to invoke and enforce arbitration 
provisions, including provisions that waive or qualify the right to 
bring a class action or any representative action in court. Instead, 
such a contract simply does not meet the conditions for relief from the 
prohibited transaction provisions of ERISA and the Code. As a result, 
the Financial Institution and Adviser would remain fully obligated 
under both ERISA and the Code to refrain from engaging in prohibited 
transactions. In short, Section II(f)(2) does not affect the validity, 
revocability, or enforceability of a class-action waiver in favor of 
individual arbitration. This regulatory scheme is thus a far cry from 
the State judicially created rules that the Supreme Court has held 
preempted by the FAA,\50\ and the National Labor Relations Board's 
attempt to prohibit class-action waivers as an ``unfair labor 
practice.'' \51\
---------------------------------------------------------------------------

    \50\ See American Express Co. v. Italian Colors Restaurant, 133 
S. Ct. 2304 (2013); AT&T Mobility LLC v. Concepcion, 563 U.S. 333 
(2011).
    \51\ See D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 
2013).
---------------------------------------------------------------------------

    The Department has broad discretion to craft exemptions subject to 
the Department's overarching obligation to ensure that the exemptions 
are administratively feasible, in the interests of plan participants, 
beneficiaries, and IRA owners, and protective of their interests. In 
this instance, the Department has concluded that the enforcement rights 
and protections associated with class action litigation are important 
to safeguarding the Impartial Conduct Standards and other anti-conflict 
provisions of the exemption. If a Financial Institution enters into a 
contract requiring binding arbitration of class claims, the Department 
would not purport to invalidate the provision, but rather would insist 
that the Financial Institution fully comply with statutory provisions 
prohibiting conflicted fiduciary transactions in its dealings with its 
Retirement Investment customers. The FAA is not to the contrary. It 
neither limits the Department's express grant of discretionary 
authority over exemptions, nor entitles parties that enter into 
arbitration agreements to a pass from the prohibited transaction rules.
    While the Department is confident that its approach in the 
exemption does not violate the FAA, it has carefully considered the 
position taken by several commenters that the Department exceeded the 
Department's authority in including provisions in the exemption on 
class and representative claims, and the possibility that a court might 
rule that the condition regarding arbitration of class claims in 
Section II(f)(2) of the exemption is invalid based on the FAA. 
Accordingly, in an abundance of caution, the Department has 
specifically provided that Section II(f)(2) can be severable if a court 
finds it invalid based on the FAA. Specifically, Section II(f)(4) 
provides that:

    In the event that the provision on pre-dispute arbitration 
agreements for class or representative claims in paragraph (f)(2) of 
this Section is ruled invalid by a court of competent jurisdiction, 
this provision shall not be a condition of this exemption with 
respect to contracts subject to the court's jurisdiction unless and 
until the court's decision is reversed, but all other terms of the 
exemption shall remain in effect.

    The Department is required to find that the provisions of an 
exemption are administratively feasible, in the interests of plans and 
their participants and beneficiaries and IRA owners, and protective of 
participants and beneficiaries and IRA owners. The Department finds 
that the exemption with paragraph (f)(2) satisfies these requirements. 
The Department believes, consistent with the position of the SEC and 
FINRA, that the courts are generally better equipped to handle class 
claims than arbitration procedures and that the prohibition on 
contractual provisions mandating arbitration of such claims helps the 
Department make the requisite statutory findings for granting an 
exemption.
    Nevertheless, the Department has determined that, based on all the 
exemption's other conditions, it can still make the necessary findings 
to grant the exemption even without the condition prohibiting pre-
dispute agreements to arbitrate class claims. In particular, if a court 
were to invalidate the condition, the Department would still find that 
the exemption is administratively feasible, in the interests of plans 
and their participants and beneficiaries, and protective of the rights 
of the participants and beneficiaries. It would be less protective, but 
still sufficient to grant the exemption.
    The Department's adoption of the specific severability provision in 
Section II(f)(4) of the exemption should not be viewed as evidence of 
the Department's intent that no other conditions of this or the other 
exemptions granted today are severable if a court were to invalidate 
them.

[[Page 21119]]

Instead, the Department intends that invalidated provisions of the rule 
and exemptions may be severed when the remainder of the rule and 
exemptions can function sensibly without them.\52\
---------------------------------------------------------------------------

    \52\ See Davis County Solid Waste Management v. United States 
Environmental Protection Agency, 108 F.3d 1454, 1459 (D.C. Cir. 
1997) (finding that severability depends on an agency's intent and 
whether the provisions can operate independently of one another).
---------------------------------------------------------------------------

c. Remedies
    Some commenters asked whether the proposal's prohibition of 
exculpatory clauses would affect the parties' ability to limit remedies 
under the contract, particularly regarding liquidated damages, punitive 
damages, consequential damages and rescission. In response, the 
Department has added text to Section II(f)(2) in the final exemption 
clarifying that the parties, in an individual or class claim, may not 
agree to an amount representing liquidated damages for breach of the 
contract. However, the exemption, as finalized, expressly permits the 
parties to knowingly agree to waive the Retirement Investor's right to 
obtain punitive damages or rescission of recommended transactions to 
the extent such a waiver is permissible under applicable state or 
federal law.
    In the Department's view, it is sufficient to the exemptions' 
protective purposes to permit recovery of actual losses. The 
availability of such a remedy should ensure that plaintiffs can be made 
whole for any losses caused by misconduct, and provide an important 
deterrent for future misconduct. Accordingly, the exemption does not 
permit the contract to include liquidated damages provisions, which 
could limit Retirement Investors' ability to obtain make-whole relief.
    On the other hand, the exemption permits waiver of punitive damages 
to the extent permissible under governing law. Similarly, rescission 
can result in a remedy that is disproportionate to the injury. In cases 
where an advice fiduciary breached its obligations, but there was no 
injury to the participant, a rescission remedy can effectively make the 
fiduciary liable for losses caused by market changes, rather than its 
misconduct. These new provisions in section II(f)(2) only apply to 
waiver of the contract claims; they do not qualify or limit statutory 
enforcement rights under ERISA. Those statutory remedies generally 
provide for make-whole relief and to rescission in appropriate cases, 
but they do not provide for punitive damages.
9. General Conditions Applicable to Each Transaction (Section III)
    Section III of the exemption sets forth conditions that apply to 
the terms of each principal transaction or a riskless principal 
transaction entered into under the exemption. Section III(a) applies 
only to purchases by a Plan, participant or beneficiary account, or 
IRA, of principal traded assets that are debt securities, as defined in 
the exemption. Section III(b) and (c) apply to both purchase and sale 
transactions, involving all principal traded assets. Many comments were 
received with respect to the proposed conditions, and the Department 
has revised the proposed language to address these comments.
a. Issuer/Underwriter Restrictions
    Section III(a)(1) and (2) of the exemption provides that the debt 
security being bought by the Plan, participant or beneficiary account, 
or IRA must not have been issued or, at the time of the transaction, 
underwritten by the Financial Institution or any Affiliate. The 
Department received comments generally objecting to these conditions as 
unduly limiting investment opportunities to Retirement Investors. 
Commenters argued that many debt securities will only be available for 
purchase by a Retirement Investor on a principal basis as part of the 
initial issuance or underwriting since the debt securities are not 
frequently resold in small lots to retail investors on either a 
principal or an agency basis.
    The Department is sympathetic to the commenters' position, but has 
determined to adopt the language without modification. This reflects 
the Department's concerns that additional conflicts of interest are 
inherent in transactions where the issuer or underwriter of a security 
(whether debt or equity) is a fiduciary to a plan or IRA. In such 
instances, the Financial Institution generally has either been retained 
by a third party to sell securities as part of an underwriting and has 
made guarantees as to such sales and will likely profit from such sales 
more than in a traditional principal transaction or is issuing 
securities on its own behalf for the specific purposes of benefiting 
itself. Further, since generally the issued or underwritten securities 
are being issued or underwritten by the Financial Institution for the 
first time, heightened issues regarding pricing and liquidity result. 
Since these unique conflicts exist with respect to both issuance and 
underwriting transactions, they would require conditions unique to 
issuance and underwriter principal transactions, respectively. This 
exemption was not designed to address such conflicts. The Department 
believes that permitting such transactions without applying additional 
conditions would not be protective of participants and beneficiaries of 
plans and IRA owners. Parties seeking relief for such transactions are 
encouraged to seek an individual exemption from the Department.
b. Credit Standards and Liquidity
    Section III(a)(3) of the exemption requires that, using information 
reasonably available to the Adviser at the time of the transaction, the 
Adviser must determine that the debt security being purchased by the 
Plan, participant or beneficiary account, or IRA, possesses no greater 
than a moderate credit risk and is sufficiently liquid that the debt 
security could be sold at or near its carrying value within a 
reasonably short period of time. Debt securities subject to a moderate 
credit risk should possess at least average credit-worthiness relative 
to other similar debt issues. Moderate credit risk would denote current 
low expectations of default risk, with an adequate capacity for payment 
of principal and interest.
    This condition is intended to identify investment grade securities, 
and avoid the circumstance in which an investment advice fiduciary can 
recommend speculative debt securities and then sell them to the Plan, 
participant or beneficiary account, or IRA, from its own inventory. The 
SEC used similar provisions in setting credit standards in its 
regulations, including its Rule 6a-5 issued under the Investment 
Company Act.\53\
---------------------------------------------------------------------------

    \53\ 17 CFR 270.6a-5, 77 FR 70117 (November 23, 2012).
---------------------------------------------------------------------------

    Some commenters on this aspect of the proposal generally objected 
to the condition's lack of objectivity. Some requested that the 
Department instead specifically condition the exemption on the 
security's being ``investment grade,'' rather than the proposed credit 
and liquidity standards. While the Department generally intends the 
exemption to be limited to securities that a reasonable investor would 
treat as investment grade securities, Section 939A of the Dodd-Frank 
Act provides that the Department may not ``reference or rely on'' 
credit ratings--including ``investment grade''--in the exemption's 
conditions. Accordingly, Advisers and Financial Institutions wishing to 
rely on the exemption must make a reasonable determination of 
creditworthiness,

[[Page 21120]]

without automatic adherence to specified credit ratings.
    Another commenter suggested that the Department replace the 
liquidity component of the standard with the provision of two quotes or 
a requirement that the Financial Institution reasonably believe a 
principal transaction provides a better price than would be available 
in the absence of a principal transaction. The Department agrees that 
it is important that the price of the principal transaction or a 
riskless principal transaction is reasonable and has conditioned the 
exemption on the Adviser and Financial Institution's commitment to seek 
to obtain the best execution reasonably available under the 
circumstances with respect to the transaction (and for FINRA members, 
specifically on satisfaction of FINRA rules 2121 (Fair Prices and 
Commissions) and 5310 (Best Execution and Interpositioning)). However, 
the Department determined not to replace the liquidity component with 
the two quote requirement in light of commenters' views that the 
requirement was unlikely to be workable or effective in achieving the 
Department's aims.
    Other commenters focused on the timing associated with the 
liquidity component of the condition. They expressed concern that the 
condition may apply throughout the time period in which the security is 
held by the Retirement Investor. The Department revised the operative 
text to make clear that the standard must be satisfied based on the 
information reasonably available to the Adviser at the time of the 
transaction and not thereafter. Nevertheless, the Department notes that 
the Adviser's consideration of whether the recommendation is in the 
Retirement Investor's Best Interest may also need to include 
consideration of information that is reasonably available regarding 
restrictions or near term expected performance of the debt security, in 
light of the Retirement Investor's needs and objectives. The Department 
additionally eliminated the credit standards with respect to sales from 
a plan, participant or beneficiary account, or IRA; accordingly, this 
condition will not stand in the way of a plan or IRA selling a security 
that no longer meets the credit standards to a Financial Institution in 
a principal transaction. The purpose of the liquidity condition was to 
protect Retirement Investors from the dangers associated with a 
conflicted Adviser saddling them with low-quality securities, not to 
prevent them from disposing of such securities.
    Commenters also argued that although the Department cited the 
similar credit standards set forth in the SEC's Rule 6a-5 issued under 
the Investment Company Act, the Department's reliance on SEC language 
as a template for the credit risk language is not necessarily 
appropriate because the SEC uses the language for a different purpose 
unrelated to retail accounts. While in a different context, the SEC's 
adoption of similar language supports the Department's view that 
Financial Institutions are capable of implementing the standard. For 
that reason, the SEC language remains relevant. Further, the Department 
itself has previously proposed the use of the same language in multiple 
class exemptions without material objections by the financial services 
industry to the workability of the language.\54\
---------------------------------------------------------------------------

    \54\ See, 78 FR 37572 (June 21, 2013).
---------------------------------------------------------------------------

    Some commenters also indicated that the Department's use of the 
term ``fair market value'' in the proposal, in place of the term 
``carrying value,'' that is used in the SEC standard, was confusing. In 
response, the Department revised the final exemption to use the term 
``carrying value'' rather than ``fair market value.'' In addition, the 
Department adopted the suggestion of a commenter that Financial 
Institutions be required to establish policies and procedures to 
determine how credit risk and liquidity assessments will be made and to 
develop standards for such assessments. This requirement is in Section 
II(d), discussed above, and is intended to provide a mechanism for 
Financial Institutions to operationalize this requirement. As revised, 
the Department believes that the credit standards condition can serve a 
protective role without being too vague or operationally difficult.
    In addition to operational concerns, commenters addressed whether 
credit standards should be part of the exemption at all. Some 
commenters opposed both the credit and liquidity conditions on the 
grounds that the Department was substituting the Department's judgment 
for the judgment of Retirement Investors. Other commenters, however, 
supported the Department's approach as imposing appropriate safeguards 
against the added risk associated with investment advice fiduciaries 
recommending principal transactions and riskless principal transactions 
involving securities that possess substantial credit risk or are thinly 
traded.
    The Department has decided to retain the credit standards. First, 
the exemption addresses only those principal transactions and riskless 
principal transactions that are the result of the provision of 
fiduciary investment advice. To the extent that a Retirement Investor 
is truly acting on his or her own without the advice of an investment 
advice fiduciary, the necessary exemptive relief already exists. As 
discussed above, Part II of PTE 75-1 currently provides relief from 
ERISA section 406(a) for principal transactions so long as the broker-
dealer or bank does not render investment advice with respect to the 
assets involved in the principal transaction. Second, the most commonly 
held categories of debt securities will continue to be available to 
plans and IRAs.
    Most importantly, with respect to investment advice that is being 
provided by an investment advice fiduciary, the Department believes 
that inherent conflicts of interest justify the credit and liquidity 
conditions. As discussed elsewhere in this preamble, principal 
transactions in particular raise significant conflicts of interest, and 
are often associated with substantial pricing, transparency and 
liquidity issues. These concerns are magnified when a debt security is 
of lesser quality. Further, beyond the Department's heightened concerns 
regarding pricing, transparency and liquidity, Financial Institutions 
may generate higher levels of compensation with respect to lower 
quality debt securities, generating additional conflicts that would 
otherwise be absent from principal transactions and riskless principal 
transactions. Finally, the Department notes that other prohibited 
transaction exemptions granted by the Department permitting principal 
transactions between plans and plan fiduciaries also contain similar 
credit standards.\55\
---------------------------------------------------------------------------

    \55\ See PTE 75-1, Part IV, Exemptions from Prohibitions 
Respecting Certain Classes of Transactions Involving Employee 
Benefit Plans and Certain Broker-Dealers, Reporting Dealers and 
Banks, 40 FR 50845 (Oct. 31, 2006), proposed amendment pending, 78 
FR 37572 (Friday, June 21, 2013).
---------------------------------------------------------------------------

c. Agreement, Arrangement or Understanding
    Section III(b) provides that a principal transaction or a riskless 
principal transaction may not be part of an agreement, arrangement, or 
understanding designed to evade compliance with ERISA or the Code, or 
to otherwise impact the value of the principal traded asset. Such a 
condition protects against the Adviser or Financial Institution 
manipulating the terms of the principal transaction or a riskless 
principal transaction, either as an isolated transaction or as a part 
of a

[[Page 21121]]

series of transactions, to benefit themselves or their Affiliates. 
Further, this condition would also prohibit an Adviser or Financial 
Institution from engaging in principal transactions with Retirement 
Investors for the purpose of ridding inventory of unwanted or poorly 
performing principal traded assets. The Department did not receive 
comments on this condition, and it has been adopted as proposed, with 
the substitution of the term ``principal traded asset'' for ``debt 
security.''
d. Cash
    Section III(c) requires that the purchase or sale of the principal 
traded asset must be for no consideration other than cash. By limiting 
a purchase or sale to cash consideration, the Department intends that 
relief will not be provided for a principal transaction or a riskless 
principal transaction that is executed on an in-kind basis. The 
limitation to cash reflects the Department's concern that in-kind 
transactions create complexity and additional conflicts of interest 
because of the need to value the in-kind asset involved in the 
transaction. The Department did not receive comments on this condition, 
and it was adopted as proposed.
e. Proposed Pricing Condition
    Section III(d) of the proposal addressed the pricing of the 
principal transaction by proposing that the purchase or sale occur at a 
price that (1) the Adviser and Financial Institution reasonably believe 
is at least as favorable to the plan, participant or beneficiary 
account, or IRA, as the price available in a transaction that is not a 
principal transaction, and (2) is at least as favorable to the plan, 
participant or beneficiary account, or IRA, as the contemporaneous 
price for the security, or a similar security if a price is not 
available for the same security, offered by two ready and willing 
counterparties that are not Affiliates of the Adviser or Financial 
Institution. The proposal further provided that when comparing the 
prices, the Adviser and Financial Institution could take into account 
commissions and mark-ups/mark-downs.
    Many commenters raised concerns regarding the practicality of the 
two quote process outlined in proposed Section III(d)(2). A number of 
commenters did not believe that the two quote process would be 
workable. They said that two quotes may not be available on all 
securities, particularly corporate debt securities. They further 
expressed uncertainty about the meaning of the ``similar securities'' 
that could be substituted. In addition, commenters indicated that the 
time needed to go through the two quote process could interfere with a 
Financial Institution's duty of best execution under FINRA rule 5310, 
or in any event could slow the execution of a transaction, to the 
detriment of the Retirement Investor. FINRA suggested the exemption 
should be conditioned on FINRA rule 5310 instead of the proposed two 
quote requirement.
    Further, the Department has come to believe that the quotes 
themselves may not be reliable measure of fair price because they are 
solicited as comparisons rather than with the intent to purchase or 
sell. A Financial Institution might be less than rigorous in its 
solicitation of the two quotes, perhaps seeking quotes that simply 
validate the Financial Institution's opinion of the appropriate price 
for the principal transaction. In light of such comments and concerns, 
the Department did not adopt the two quote requirement.
    However, in order to address the Department's concern about the 
price of the transaction, as discussed in more detail above, the 
exemption requires that Advisers and Financial Institutions engaging in 
the transactions seek to obtain the best execution reasonably available 
under the circumstances. For FINRA members, the final exemption 
provides that they must comply with FINRA rules 2121 and 5310. These 
rules provide for best execution and fair pricing, and they will ensure 
that the Financial Institution does not use its relationship with a 
plan or IRA to benefit financially to the detriment of the plan or IRA.
    One commenter expressed strong support for the intent behind the 
pricing conditions to protect Retirement Investors. The commenter 
expressed concern, however, that Financial Institutions could work 
around the proposed pricing conditions, resulting in the conditions 
failing to provide the anticipated protections to Retirement Investors. 
The commenter suggested that Financial Institutions be required to 
articulate why the principal transaction is in the Retirement 
Investor's Best Interest and provide current market data, available 
from FINRA's TRACE system, for example, to back up such articulation. 
Another commenter also suggested that specific pricing information 
could be made available on request.
    The Department believes that the Department's approach in Section 
II(c)(2) of the final exemption Impartial Conduct Standards implements 
the intent of the pricing condition proposed in Section III(d)(1). The 
Department did not adopt the suggestion to require the provision of 
current market data based upon its concern that the additional costs 
would likely outweigh the benefits, particularly for retail investors. 
Because of the nature of the marketplace for principal traded assets, 
current market data is often difficult to analyze and apply to an 
individual transaction involving the same asset. Such difficulties are 
particularly problematic with respect to less sophisticated Retirement 
Investors who will not have the analytic tools at their disposal to 
interpret any market data that could be provided to them. Consequently, 
disclosure of such data would likely be of limited value to retail 
investors. To the extent that the information would be useful to more 
sophisticated Retirement Investors, such Retirement Investors typically 
have the information and necessary analytic tools already available.
10. Disclosure Requirement (Section IV)
a. Pre-Transaction Disclosure
    Section IV(a) of the exemption requires that, prior to or at the 
same time as the execution of the transaction, the Adviser or Financial 
Institution must provide the Retirement Investor, orally or in writing, 
a disclosure of the capacity in which the Financial Institution may act 
with respect to the transaction. By ``capacity in which the Financial 
Institution may act,'' the Department means that the Financial 
Institution must notify the Retirement Investor if it may act as 
principal in the transaction. This requirement is intended to harmonize 
with the SEC's Temporary Rule 206(3)-3T, which has a similar pre-
transaction requirement. Such a harmonization allows for a streamlined 
disclosure requirement, which places less burden on the Financial 
Institutions.
    In the proposal, Section IV(a) would have required the Adviser or 
Financial Institution to provide a statement, prior to engaging in the 
principal transaction, that the purchase or sale would be executed as a 
principal transaction. A few commenters indicated that they would not 
always know if the transaction would be executed as a principal 
transaction prior to the transaction. These commenters suggested that 
the Department adopt the approach in the SEC's Temporary Rule 206(3)-
3T, which a commenter said, requires that an investment adviser inform 
the client ``of the capacity in which it may act with respect to such 
transaction.'' A commenter said this formulation recognized that the 
investment adviser may not know at

[[Page 21122]]

that time whether the transaction would be executed as a principal 
transaction. The Department concurs with this comment and has revised 
the pre-transaction disclosure to more closely match the language in 
the SEC's Temporary Rule.
    Some commenters indicated that the Department's requirement in 
Section IV(a) was burdensome in that they perceived it to require the 
Retirement Investor's affirmative consent to the specific terms of the 
transaction in advance of the execution. In response, the Department 
notes that the proposal did not, and the final exemption does not, 
contemplate such consent. However, the Department notes that the 
exemption is limited to Advisers and Financial Institutions that act in 
a non-discretionary capacity.
    The proposed pre-transaction disclosure also would have required 
disclosure of the two quotes received from unrelated counterparties and 
the mark-up, mark-down or other payment to be applied to the principal 
transaction.\56\ Commenters pointed to logistical problems involved in 
determining a true mark-up/mark-down amount when multiple, unrelated 
brokers facilitate the principal transaction. They asserted that, in 
the absence of contextual information, the disclosure of the mark-up/
mark-down may not be useful to Retirement Investors. A few commenters 
suggested that the Department require the disclosure of the maximum and 
minimum possible mark-up or mark-down, with one commenter suggesting 
that more specific information could be made available upon request. 
The preamble to the proposed exemption discussed the possibility of 
defining the mark-up/mark-down by reference to FINRA rule 2121 and the 
related guidance, and asked for comment on the approach. One commenter, 
however, said the Department did not provide any methodology for the 
mark-up/mark-down disclosure requirement and, as a result, the 
Department's approach would lead to confusion and inconsistent 
application of the pricing condition. Other commenters suggested that 
the Department defer to other regulatory and legislative initiatives 
regarding mark-up/mark-down disclosure--in particular, FINRA's proposed 
disclosures in FINRA Regulatory Notice 14-52.
---------------------------------------------------------------------------

    \56\ As discussed above, the proposed two quote requirement was 
not adopted in the final exemption.
---------------------------------------------------------------------------

    The Department was persuaded by the commenters that required 
disclosure of the mark-up or mark-down might introduce significant 
complexity to compliance with the exemption, in particular with respect 
to transactions that could be covered by FINRA's pending disclosure 
requirement, and therefore has not adopted the mark-up/mark-down 
disclosure requirement in the final exemption. Commenters' suggestions 
to require disclosure of the minimum and maximum mark-up/mark-down were 
not adopted because the Department believes that this disclosure would 
not be specific enough to benefit Retirement Investors.
b. Confirmation
    Section IV(b) of the proposal would have required a written 
confirmation in accordance with Rule 10b-10 under the Exchange Act, 
that also includes disclosure of the mark-up, mark-down or other 
payment to be applied to the principal transaction. A number of 
comments noted that Rule 10b-10 does not currently include disclosure 
of the mark-up or mark-down, and making the change would be costly. 
There were also significant comments, discussed elsewhere, as to the 
practicality of the mark-up or mark-down disclosure, such that the 
Department determined not to require the disclosure as discussed above. 
As a result, the requirement to include a mark-up or mark-down as part 
of the confirmation has been eliminated. Section IV(b) now simply 
requires the issuance of a confirmation of the transaction. The 
requirement to provide a confirmation may be met by compliance with the 
existing Rule 10b-10, or any successor rule in effect at the time of 
the transaction, or for Advisers and Financial Institutions not subject 
to the Exchange Act, similar requirements imposed by another regulator 
or self-regulatory organization.
c. Annual Disclosure
    Section IV(c) sets forth a requirement under which the Adviser or 
Financial Institution must provide certain written information clearly 
and prominently in a single written disclosure to the Retirement 
Investor on an annual basis. The annual disclosure must include: (1) A 
list identifying each principal transaction and riskless principal 
transaction executed in the Retirement Investor's account in reliance 
on this exemption during the applicable period and the date and price 
at which the transaction occurred; and (2) a statement that (i) the 
consent required pursuant to Section II(e)(2) is terminable at will 
upon written notice, without penalty to the Plan or IRA, (ii) the right 
of a Retirement Investor in accordance with Section II(e)(3)(ii) to 
obtain, free of charge, information about the Principal Traded Asset, 
including its salient attributes, (iii) model contract disclosures or 
other model notice of the contractual terms which are reviewed for 
accuracy no less than quarterly updated within 30 days as necessary are 
maintained on the Financial Institution's Web site, and (iv) the 
Financial Institution's written description of its policies and 
procedures adopted in accordance with Section II(d) are available free 
of charge on the Financial Institution's Web site.
    With respect to this requirement, Section IV(d) of the exemption 
includes a good faith compliance provision, under which the Financial 
Institution will not fail to satisfy Section IV solely because it, 
acting in good faith and with reasonable diligence, makes an error or 
omission in disclosing the required information or if the Web site is 
temporarily inaccessible, provided that (i) in the case of an error or 
omission on the web, the Financial Institution discloses the correct 
information as soon as practicable, but not later than 7 days after the 
date on which it discovers or reasonably should have discovered the 
error or omission, and (ii) in the case of other disclosures, the 
Financial Institution discloses the correct information as soon as 
practicable, but not later than 30 days after that date on which it 
discovers or reasonably should have discovered the error or omission. 
In addition, to the extent compliance with the annual disclosure 
requires Advisers and Financial Institutions to obtain information from 
entities that are not closely affiliated with them, the exemption 
provides that they may rely in good faith on information and assurances 
from the other entities, as long as they do not know that the materials 
are incomplete or inaccurate. This good faith reliance applies unless 
the entity providing the information to the Adviser and Financial 
Institution is (1) a person directly or indirectly through one or more 
intermediaries, controlling, controlled by, or under common control 
with the Adviser or Financial Institution; or (2) any officer, 
director, employee, agent, registered representative, relative (as 
defined in ERISA section 3(15)), member of family (as defined in Code 
section 4975(e)(6)) of, or partner in, the Adviser or Financial 
Institution.
    The proposal included an annual disclosure requirement in Section 
IV(c) that would have included the following elements:

    (1) A list identifying each principal transaction engaged in 
during the applicable period, the prevailing market price at which 
the Debt Security was purchased or sold, and

[[Page 21123]]

the applicable mark-up or mark-down or other payment for each Debt 
Security; and
    (2) A statement that the consent required pursuant to Section 
II(e)(2) is terminable at will, without penalty to the Plan or IRA.

    The disclosure would have been required to be made within 45 days 
after the end of the applicable year.
    As finalized, the annual disclosure now includes a list of the 
principal transactions and riskless principal transactions entered into 
in reliance on this exemption, and the date and price at which they 
occurred. As discussed elsewhere in this preamble, the final exemption 
does not include the disclosure of the mark-up or mark-down in this 
final exemption. However, the disclosure in the final exemption 
includes a reminder of the Retirement Investor's right (in accordance 
with Section II(e)(3)(ii) of the exemption) to obtain, free of charge, 
information about the principal traded asset, including its salient 
attributes.
    The final exemption also more closely harmonizes with the SEC's 
Temporary Rule 206(3)-3T, as requested by some commenters. First, the 
Department removed the proposed condition that the annual disclosure be 
provided within 45 days after the end of the applicable year, in favor 
of the language used in the Temporary Rule that the disclosure be 
provided ``no less frequently than annually.'' Second, the Department 
added the requirement that the annual disclosure provide the date on 
which the transaction occurred, and a clarification that the disclosure 
is only required with respect to principal transactions and riskless 
principal transactions entered into pursuant to this exemption. These 
elements also harmonize with the SEC's Temporary Rule. As with the pre-
transaction disclosure, the harmonization of the annual disclosure 
should ease compliance for Financial Institutions.
    The Department adopted the annual disclosure, despite comments 
indicating it was unnecessary and duplicative of other disclosures. The 
annual disclosure provides a summary of the principal transactions and 
riskless principal transactions entered into during the reporting 
period and serves a unique purpose in collecting the information 
provided in the other disclosures. The annual disclosure provides 
Retirement Investors with the opportunity to review and evaluate all of 
the principal transactions and riskless principal transactions that 
occurred under the terms of the exemption during that period. The 
information provided may give Retirement Investors perspective that 
they do not gain from the individual confirmations.
    Finally, a few commenters objected to Section IV(d) of the 
proposal, which would have required disclosure of information about the 
debt security and its purchase or sale, upon reasonable request of the 
Retirement Investor. Such right of request was viewed as unbounded. The 
Department concurs with the commenters and has deleted Section IV(d). 
The Department believes the provision in Section IV(c)(2), that a 
notice must be provided of the Retirement Investor's right to obtain, 
free of charge, information about the Principal Traded Asset, including 
its salient attributes, serves the same function. As discussed above, 
one commenter requested that the information must be reasonably 
available and in the Financial Institution's possession. The Department 
believes that no additional limitation need be placed on the rights of 
the Retirement Investor to request information because, if a Financial 
Institution is advising a Retirement Investor to enter into a principal 
transaction or a riskless principal transaction, it should have all of 
the salient information available when providing that advice.
11. Recordkeeping (Section V)
    Under Section V(a) and (b) of the exemption, the Financial 
Institution must maintain for six years records necessary for the 
Department and certain other entities, including plan fiduciaries, 
participants, beneficiaries and IRA owners, to determine whether the 
conditions of the exemption have been satisfied. Some commenters stated 
that they were unsure what information would have to be saved for six 
years. The Department notes that the language requires that records 
necessary to demonstrate compliance with the exemption's conditions 
must be maintained.
    The final exemption includes changes to the recordkeeping provision 
made in accordance with comments on other exemption proposals in 
connection with the Regulation. First, the text was revised to make 
clear that the records must be ``reasonably accessible for 
examination,'' to remove the subjective views of the person requesting 
to examine or audit the records. The section also clarifies that 
fiduciaries, employers, employee organizations, participants and their 
employees and representatives only have access to information 
concerning their own plans. In addition, Financial Institutions are not 
required to disclose privileged trade secrets or privileged commercial 
or financial information to any of the parties other than the 
Department, as was also true of the proposal. Financial Institutions 
are also not required to disclose records if such disclosure would be 
precluded by 12 U.S.C. 484, relating to visitorial powers over national 
banks and federal savings associations.\57\ As revised, the exemption 
requires the records be ``reasonably'' available, rather than 
``unconditionally available.'' Finally, additional language was added 
to clarify that any failure to maintain the required records with 
respect to a given transaction or set of transactions does not affect 
the relief for other transactions.
---------------------------------------------------------------------------

    \57\ A commenter with respect to the Best Interest Contract 
Exemption raised concerns that the Department's right to review a 
bank's records under that exemption could conflict with federal 
banking laws that prohibit agencies other than the Office of the 
Comptroller of the Currency (OCC) from exercising ``visitorial'' 
powers over national banks and federal savings associations. To 
address the comment, Financial Institutions are not required to 
disclose records if the disclosure would be precluded by 12 U.S.C. 
484. A corresponding change was made in this exemption.
---------------------------------------------------------------------------

    The recordkeeping provision in the exemption is necessary to 
demonstrate compliance with the terms of the exemption and therefore 
should represent prudent business practices in any event. The 
Department notes that similar language is used in many other exemptions 
and has been the Department's standard recordkeeping requirement for 
exemptions for some time.
12. Definitions (Section VI)
    Section VI of the exemption provides definitions of the terms used 
in the exemption. Most of the definitions received no comment, and they 
are finalized as proposed. Those terms that have been revised or 
received comment are below. Additional comments on definitions, such as 
``Best Interest,'' ``Principal Transaction'' and ``Material Conflict of 
Interest,'' are discussed above in their respective sections.
a. Adviser
    The exemption contemplates that an individual person, an Adviser, 
will provide advice to the Retirement Investor. An Adviser must be an 
investment advice fiduciary of a plan or IRA who is an employee, 
independent contractor, agent, or registered representative of a 
Financial Institution, and the Adviser must satisfy the applicable 
federal and state regulatory and licensing requirements of banking and 
securities laws with respect to the covered transaction.\58\ Advisers 
may be, for example, registered representatives

[[Page 21124]]

of broker-dealers registered under the Exchange Act.
---------------------------------------------------------------------------

    \58\ See Section VI(a) of the exemption.
---------------------------------------------------------------------------

    One commenter suggested that applicable federal and state 
regulatory and licensing language, similar to that in the Best Interest 
Contract Exemption proposal, be added to the definition. The Department 
agrees with the commenter, and the exemption contains the suggested 
language.
b. Financial Institutions
    A Financial Institution is the entity that employs an Adviser or 
otherwise retains the Adviser as an independent contractor, agent or 
registered representative and customarily purchases or sells Principal 
Traded Assets for its own account in the ordinary course of its 
business.\59\ Financial Institutions must be investment advisers 
registered under the Investment Advisers Act of 1940 or state law, 
banks, or registered broker-dealers.
---------------------------------------------------------------------------

    \59\ See Section VI(e) of the exemption.
---------------------------------------------------------------------------

    The Department specifically requested comment on whether there are 
other types of Financial Institutions that should be included in the 
definition. No comments were received regarding the need for additional 
entities to be included. The only comments regarding the definition 
that were received addressed the language in the proposal that would 
have required that advice by a bank be delivered through the bank's 
trust department. Commenters indicated that the language serves no 
material purpose. As a result, the definition is finalized as proposed 
with the exception of the removal of the trust requirement.
c. Debt Securities and Principal Traded Assets
    As discussed in detail above with respect to the scope of the 
exemption, the Department heard from many commenters that wanted to 
expand the scope of the assets that would be eligible to participate in 
principal transactions under the exemption. After a review of 
individual investments, the Department revised the proposal to include 
asset backed securities, CDs, UITs and additional investments later 
determined to be added through individual exemptions. Further, with 
respect to sales by a plan or IRA in a principal transaction or a 
riskless principal transaction, all securities or other property are 
provided exemptive relief. The Department operationalized these 
additions by revising the proposed definition of a debt security to 
include asset backed securities guaranteed by an agency or a government 
sponsored enterprise, both within the meaning of FINRA rule 6710. 
Further, in order to capture the remaining investments, the new defined 
term ``principal traded asset'' was included in Section VI. The 
definition of a principal traded asset encompasses both the definition 
of ``debt security'' and the other investments listed herein.
    In addition to the comments discussed above, one commenter stated 
that requiring that a debt security be offered pursuant to a 
registration statement under the Securities Act of 1933 was difficult 
to comply with operationally in the secondary market. The commenter 
argued that the requirement could be eliminated in reliance on the Best 
Interest standard. The Department does not agree, and the language is 
finalized as proposed. Requiring that a security be registered is a 
straightforward mechanism by which the Department can ensure a base 
level of regulatory compliance and quality. An Adviser or Financial 
Institution should be able to verify the registration of a particular 
debt security by using a variety of sources.
d. Affiliate
    Section VI(b) defines ``Affiliate'' of an Adviser or Financial 
Institution as:

    (1) Any person directly or indirectly through one or more 
intermediaries, controlling, controlled by, or under common control 
with the Adviser or Financial Institution. For this purpose, the 
term ``control'' means the power to exercise a controlling influence 
over the management or policies of a person other than an 
individual;
    (2) Any officer, director, partner, employee, or relative (as 
defined in ERISA section 3(15)), of the Adviser or Financial 
Institution; or
    (3) Any corporation or partnership of which the Adviser or 
Financial Institution is an officer, director, or partner of the 
Adviser or Financial Institution.

    The Department received a comment requesting that this definition 
adopt a securities law definition. The commenter expressed the view 
that use of a separate definition would make compliance more difficult 
for broker-dealers. The Department did not accept this comment. 
Instead, the Department made minor adjustments so that the definition 
is identical to the affiliate definition incorporated in prior 
exemptions under ERISA and the Code, that are applicable to broker 
dealers,\60\ as well as the definition that is used in the Regulation. 
Therefore, the definition should not be new to the broker-dealer 
community, and is consistent with other applicable laws.
---------------------------------------------------------------------------

    \60\ See, e.g., PTE 75-1, Part II, 40 FR 50845 (Oct. 31, 1975), 
as amended at 71 FR 5883 (Feb. 3, 2006).
---------------------------------------------------------------------------

e. Independent
    The term Independent is used in Section I(c)(2)(ii), which 
precludes Financial Institutions and Advisers from relying on the 
exemption if they are the named fiduciary or plan administrator, as 
defined in ERISA section 3(16)(A), with respect to an ERISA-covered 
plan, unless such Financial Institutions or Advisers are selected to 
provide advice to the plan by a plan fiduciary that is Independent of 
the Financial Institutions or Advisers.
    In the proposed exemption, the definition of Independent provided 
that the person (e.g., the independent fiduciary appointing the Adviser 
or Financial Institution under Section I(c)(2)(ii)) could not receive 
any compensation or other consideration for his or her own account from 
the Adviser, the Financial Institution or an Affiliate. A commenter 
indicated that as a result, a number of parties providing services to 
the Financial Institution, and receiving compensation in return, could 
not satisfy the Independence requirement. The commenter suggested 
defining entities that receive less than 5% of their gross income from 
the fiduciary as Independent.
    In response, the Department revised the definition of Independent 
so that it provides that the person's compensation from the Financial 
Institution may not be in excess of 2% of the person's annual revenues 
based on the prior year. This approach is consistent with the 
Department's general approach to fiduciary independence. For example, 
the prohibited transaction exemption procedures provide a presumption 
of independence for appraisers and fiduciaries if the revenue they 
receive from a party is not more than 2% of their total annual 
revenue.\61\ The Department has revised the definition accordingly.\62\
---------------------------------------------------------------------------

    \61\ 29 CFR 2570.31(j).
    \62\ The same commenter also requested clarification that an IRA 
owner will not be deemed to fail the Independence requirement simply 
because he or she is an employee of the Financial Institution. 
However, the Independence is not applicable to IRA owners.
---------------------------------------------------------------------------

C. Good Faith

    Commenters requested that the exemption continue to apply in the 
event of a Financial Institution's or Adviser's good faith failure to 
comply with one or more of the conditions. In the commenters' views, 
the exemption was sufficiently complex and the implementation timeline 
sufficiently short to justify such a provision. For example, FINRA 
suggested that the Department include a provision for continued 
application of the exemption

[[Page 21125]]

despite a failure to comply with ``any term, condition or requirement 
of this exemption . . . if the failure to comply was insignificant and 
a good faith and reasonable attempt was made to comply with all 
applicable terms, conditions and requirements.'' Several commenters 
specifically supported FINRA's suggestion.
    The Department has reviewed the exemption's requirements with these 
comments in mind and has included a good faith correction mechanism for 
the disclosure requirements in the exemption. These provisions take a 
similar approach to the provisions in the Department's regulations 
under ERISA sections 404 and 408(b)(2). In addition, as discussed 
above, the Department has eliminated a condition requiring compliance 
with other federal and state laws, which many commenters had argued 
could expose them to loss of the exemption based on small or technical 
violations. The Department has also facilitated compliance by 
streamlining the contracting process (and eliminating the contract 
requirement for ERISA plans), reducing the disclosure burden, and 
extending the time for compliance with many of the exemption's 
conditions. These and other changes should reduce the need for a self-
correction process for excusing violations.
    The Department declines to permanently adopt a broader unilateral 
good faith provision for Financial Institutions and their Advisers that 
could undermine fiduciaries' incentive to comply with the fundamental 
standards imposed by the exemption. The exemption's primary purpose is 
to combat harmful conflict of interest. If the exemption is too 
forgiving of abusive conduct, however, it runs the risk of permitting 
those same conflicts of interest to play a role in the design of 
policies and procedures, the use and oversight of adviser-incentives, 
the supervision of Adviser conduct, and the substance of investment 
recommendations. At the very least, it could encourage Financial 
Institutions and Advisers to resolve doubts on such questions in favor 
of their own financial interests rather than the interests of the 
Retirement Investor. Given the dangers posed by conflicts, the 
Department has deliberately structured this exemption to provide a 
strong counter-incentive to such conduct.
    Additionally, many of the exemption's standards, such as the Best 
Interest standard and the pricing condition, already have a built-in 
reasonableness or prudence standard governing compliance. It would be 
inappropriate, in the Department's view, to create a self-correction 
mechanism for conduct that was imprudent or unreasonable. For example, 
the Best Interest standard requires that the Adviser and Financial 
Institution providing the advice act with the care, skill, prudence, 
and diligence under the circumstances then prevailing that a prudent 
person acting in a like capacity and familiar with such matters would 
use in the conduct of an enterprise of a like character and with like 
aims, based on the investment objectives, risk tolerance, financial 
circumstances, and needs of the Retirement Investor, without regard to 
the financial or other interests of the Adviser, Financial Institution 
or any Affiliate, Related Entity, or other party. Similarly, the 
policies and procedures requirement under Section II(d) turns to a 
significant degree on adherence to standards of prudence and 
reasonableness. Thus, under Section II(d)(1), the Financial Institution 
is required to adopted and comply with written policies and procedures 
reasonably and prudently designed to ensure that its individual 
Advisers adhere to the Impartial Conduct Standards set forth in Section 
II(c).
    Additionally, the provision allowing mandatory arbitration of 
individual claims is also responsive to the practicalities of resolving 
disputes over small claims. The Department also stresses that 
violations of the exemption's conditions with respect to a particular 
Retirement Investor or transaction, eliminates the availability of the 
exemption for that investor or transaction. Such violations do not 
render the exemption unavailable with respect to other Retirement 
Investors or other transactions.

D. Jurisdiction

    The Department received a number of comments questioning the 
Department's jurisdiction and legal authority to proceed with the 
proposal. A number of commenters focused on the Department's authority 
to impose certain conditions as part of this exemption, specifically 
including the contract requirement and the Impartial Conduct Standards. 
Some commenters asserted that by requiring a contract for all 
Retirement Investors, and thereby facilitating contract claims by such 
parties, the proposal would expand upon the remedies established by 
Congress under ERISA and the Code. Commenters stated that ERISA 
preempts state law actions, including breach-of-contract actions. With 
respect to IRAs and non-ERISA plans, commenters stated that Congress 
provided that the enforcement of the prohibited transaction rules 
should be carried out by the Internal Revenue Service, not private 
plaintiffs. These commenters argued that the Department's proposal 
would impermissibly create a private right of action in violation of 
Congressional intent.
    Commenters' arguments regarding the Impartial Conduct Standards 
were based generally on the fact that the standards, as noted above, 
are consistent with longstanding principles of prudence and loyalty set 
forth in ERISA section 404, but which have no counterpart in the Code. 
Commenters took the position that because Congress did not choose to 
impose the standards of prudence and loyalty on fiduciaries with 
respect to IRAs and non-ERISA plans, the Department exceeded its 
authority in proposing similar standards as a condition of relief in a 
prohibited transaction exemption.
    With respect to ERISA plans, commenters stated that Congress' 
separation of the duties of prudence and loyalty (in ERISA section 404) 
from the prohibited transaction provisions (in ERISA section 406), 
showed an intent that the two should remain separate. Commenters 
additionally questioned why the conduct standards were necessary for 
ERISA plans, when such plans already have an enforceable right to 
fiduciary conduct that is both prudent and loyal. Commenters asserted 
that imposing the Impartial Conduct Standards as conditions of the 
exemption improperly created strict liability for prudence violations.
    Some commenters additionally took the position that Congress, in 
the Dodd-Frank Act, gave the SEC the authority to establish standards 
for broker-dealers and investment advisers and therefore, the 
Department did not have the authority to act in that area.
    The Department disagrees that the exemption exceeds its authority. 
The Department has clear authority under ERISA section 408(a) and the 
Reorganization Plan \63\ to grant administrative exemptions from the 
prohibited transaction provisions of both ERISA and the Code. Congress 
gave the Department broad discretion to grant or deny exemptions and to 
craft conditions for those exemptions, subject only to the overarching 
requirement that the exemption be administratively feasible, in the 
interests of plans, plan participants and beneficiaries and IRA owners, 
and protective of their rights.\64\ Nothing in ERISA or the Code 
suggests

[[Page 21126]]

that, in exercising its express discretion to fashion appropriate 
conditions, the Department cannot condition exemptions on contractual 
terms or commitments, or that, in crafting exemptions applicable to 
fiduciaries, the Department is forbidden to borrow from time-honored 
trust-law standards and principles developed by the courts to ensure 
proper fiduciary conduct.
---------------------------------------------------------------------------

    \63\ See fn. 1, supra, discussing of Reorganization Plan No. 4 
of 1978 (5 U.S.C. app. at 214 (2000)).
    \64\ See ERISA section 408(a) and Code section 4975(c)(2).
---------------------------------------------------------------------------

    In addition, this exemption does not create a cause of action for 
plan fiduciaries, participants or IRA owners to directly enforce the 
prohibited transaction provisions of ERISA and the Code in a federal or 
state-law contract action. Instead, with respect to ERISA plans and 
participants and beneficiaries, the exemption facilitates the existing 
statutory enforcement framework by requiring Financial Institutions to 
acknowledge in writing their fiduciary status and the fiduciary status 
of their Advisers. With respect to IRAs and non-ERISA plans, the 
exemption requires Advisers and Financial Institutions to make certain 
enforceable commitments to the advice recipient. Violation of the 
commitments can result in contractual liability to the Adviser and 
Financial Institution separate and apart from the legal consequences of 
a non-exempt prohibited transaction (e.g., an excise tax).
    There is nothing new about a prohibited transaction exemption 
requiring certain written documentation between the parties. The 
Department's widely-used exemption for Qualified Professional Asset 
Managers (QPAM), requires that an entity acting as a QPAM acknowledge 
in a written management agreement that it is a fiduciary with respect 
to each plan that has retained it.\65\ Likewise, PTE 2006-16, an 
exemption applicable to compensation received by fiduciaries in 
securities lending transactions, requires the compensation to be paid 
in accordance with the terms of a written instrument.\66\ Surely, the 
terms of these documents can be enforced by the parties. In this 
regard, the statutory authority permits, and in fact requires, that the 
Department incorporate conditions in administrative exemptions designed 
to protect the interests of plans, participants and beneficiaries, and 
IRA owners. The Department has determined that the contract requirement 
in the final exemption serves a critical protective function.
---------------------------------------------------------------------------

    \65\ See Section VI(a) of PTE 84-14, 49 FR 9494, March 13, 1984, 
as amended at 70 FR 49305 (August 23, 2005) and as amended at 75 FR 
38837 (July 6, 2010).
    \66\ See Section IV(c) of PTE 2006-16, 71 FR 63786 (Oct. 31, 
2006).
---------------------------------------------------------------------------

    Likewise, the Impartial Conduct Standards represent, in the 
Department's view, baseline standards of fundamental fair dealing that 
must be present when fiduciaries make conflicted investment 
recommendations to Retirement Investors. After careful consideration, 
the Department determined that broad relief could be provided to 
investment advice fiduciaries receiving conflicted compensation only if 
such fiduciaries provided advice in accordance with the Impartial 
Conduct Standards--i.e., if they provided prudent advice without regard 
to the interests of such fiduciaries and their Affiliates and Related 
Entities, in exchange for reasonable compensation and without 
misleading investors. These Impartial Conduct Standards are necessary 
to ensure that Advisers' recommendations reflect the Best interest of 
their Retirement Investor customers, rather than the conflicting 
financial interests of the Advisers and their Financial Institutions. 
As a result, Advisers and Financial Institutions bear the burden of 
showing compliance with the exemption and face liability for engaging 
in a non-exempt prohibited transaction if they fail to provide advice 
that is prudent or otherwise in violation of the standards. The 
Department does not view this as a flaw in the exemption, as commenters 
suggested, but rather as a significant deterrent to violations of 
important conditions under an exemption that accommodates a wide 
variety of potentially dangerous compensation practices.
    The Department similarly disagrees that Congress' directive to the 
SEC in the Dodd-Frank Act limits its authority to establish appropriate 
and protective conditions in the context of a prohibited transaction 
exemption. Section 913 of the Dodd-Frank Act directs the SEC to conduct 
a study on the standards of care applicable to brokers-dealers and 
investment advisers, and issue a report containing, among other things:

an analysis of whether [sic] any identified legal or regulatory 
gaps, shortcomings, or overlap in legal or regulatory standards in 
the protection of retail customers relating to the standards of care 
for brokers, dealers, investment advisers, persons associated with 
brokers or dealers, and persons associated with investment advisers 
for providing personalized investment advice about securities to 
retail customers.\67\

    \67\ Dodd-Frank Act, sec. 913(d)(2)(B).
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    Section 913 of the Dodd-Frank Act authorizes, but does not require, 
the SEC to issue rules addressing standards of care for broker-dealers 
and investment advisers for providing personalized investment advice 
about securities to retail customers.\68\ Nothing in the Dodd-Frank Act 
indicates that Congress meant to preclude the Department's regulation 
of fiduciary investment advice under ERISA or its application of such a 
regulation to securities brokers or dealers. To the contrary, the Dodd-
Frank Act in directing the SEC study specifically directed the SEC to 
consider the effectiveness of existing legal and regulatory standard of 
care under other federal and state authorities.\69\ The Dodd-Frank Act 
did not take away the Department's responsibility with respect to the 
definition of fiduciary under ERISA and in the Code; nor did it qualify 
the Department's authority to issue exemptions that are 
administratively feasible, in the interests of plans, participants and 
beneficiaries, and IRA owners, and protective of the rights of 
participants and beneficiaries of the plans and IRA owners. If the 
Department were unable to rely on contract conditions and trust-law 
principles, it would be unable to grant broad relief under this 
exemption from the rigid application of the prohibited transaction 
rules. This enforceable standards-based approach enabled the Department 
to grant relief to a much broader range of practices and compensation 
structures than would otherwise have been possible.
---------------------------------------------------------------------------

    \68\ 15 U.S.C. 80b-11(g)(1).
    \69\ Dodd-Frank Act, sec. 913(b)(1) and (c)(1).
---------------------------------------------------------------------------

    Additionally, the Department notes that nothing in ERISA or the 
Code requires any Adviser or Financial Institution to use this 
exemption. Exemptions, including this class exemption, simply provide a 
means to engage in a transaction otherwise prohibited by the statutes. 
The conditions to an exemption are not equivalent to a regulatory 
mandate that conflicts with or changes the statutory remedial scheme. 
If Advisers or Financial Institutions do not want to be subject to 
contract claims, they can (1) change their trading practices and avoid 
committing a prohibited transaction, (2) use the statutory exemptions 
in ERISA section 408(b)(14) and section 408(g), or Code section 
4975(d)(17) and (f)(8), or (3) apply to the Department for individual 
exemptions tailored to their particular situations.

E. Defer to the Securities and Exchange Commission

    Many commenters suggested that a uniform standard applicable to all 
retail accounts would be preferable to the Department's proposal, and 
that the Department should work with other

[[Page 21127]]

regulators, such as the SEC and FINRA, to fashion such an approach. 
Others suggested that the Department should wait and defer to the SEC's 
determination of an appropriate standard for broker-dealers under the 
Dodd-Frank Act. Still others suggested that the Department should 
provide exemptions based on fiduciary status under securities laws, or 
based on compliance with other applicable laws or regulations. FINRA 
indicated that the proposal should be based on existing principles in 
federal securities laws and FINRA rules but acknowledged that 
additional rulemaking would be required.
    The Department disagrees with the commenters, and believes it is 
important to move forward with this proposal to remedy the ongoing 
injury to Retirement Investors as a result of conflicted advice 
arrangements. ERISA and the Code create special protections applicable 
to investors in tax qualified plans. The fiduciary duties established 
under ERISA and the Code are different from those applicable under 
securities laws, and would continue to differ even if both regimes were 
interpreted to attach fiduciary status to exactly the same parties and 
activities. Reflecting the special importance of plan and IRA 
investments to retirement and health security, this statutory regime 
flatly prohibits fiduciaries from engaging in transactions involving 
self-dealing and conflicts of interest unless an exemption applies. 
Under ERISA and the Code, the Department of Labor has the authority to 
craft exemptions from these stringent statutory prohibitions, and the 
Department is specifically charged with ensuring that any exemptions it 
grants are in the interests of Retirement Investors and protective of 
these interests. Moreover, the fiduciary provisions of ERISA and the 
Code broadly protect all investments by Retirement Investors, not just 
those regulated by the SEC. As a consequence, the Department uniquely 
has the ability to assure that these fiduciary rules work in harmony 
for all Retirement Investors, regardless of whether they are investing 
in securities, insurance products that are not securities, or other 
types of investments.
    The Department has taken very seriously its obligation to harmonize 
the Department's regulation with other applicable laws, including the 
securities laws. In pursuing its consultations with other regulators, 
the Department aimed to coordinate and minimize conflicting or 
duplicative provisions between ERISA, the Code and federal securities 
laws. The Department has coordinated--and will continue to coordinate--
its efforts with other federal agencies to ensure that the various 
legal regimes are harmonized to the fullest extent possible. The 
resulting exemption provides Advisers and Financial Institutions with a 
choice to provide advice on an unconflicted basis or comply with this 
exemption or another exemption, which now all require advice to be 
provided in accordance with basic fiduciary norms. Far from confusing 
investors, the standards set forth in the exemption ensure that 
Retirement Investors can uniformly expect to receive advice that is in 
their best interest with respect to their retirement investments. 
Moreover, the best interest standard reflects what many investors have 
believed they were entitled to all along, even though it was not 
legally required.
    In this regard, waiting for the SEC to act, as some commenters 
suggested, would delay the implementation of these important, updated 
safeguards to plan and IRA investors, and impose substantial costs on 
them as current harms from conflicted advice would continue.

F. Applicability Date and Transition Rules

    The Regulation will become effective June 7, 2016 and this 
exemption is issued on this same date. The Regulation is effective at 
the earliest possible date under the Congressional Review Act. For the 
exemption, the issuance date serves as the date on which the exemption 
is intended to take effect for purposes of the Congressional Review 
Act. This date was selected to provide certainty to plans, plan 
fiduciaries, plan participants and beneficiaries, IRAs, and IRA owners 
that the new protections afforded by the final rule are now officially 
part of the law and regulations governing their investment advice 
providers, and to inform financial services providers and other 
affected service providers that the rule and exemption are final and 
not subject to further amendment or modification without additional 
public notice and comment. The Department expects that this effective 
date will remove uncertainty as an obstacle to regulated firms 
allocating capital and other resources toward transition and longer 
term compliance adjustments to systems and business practices.
    The Department has also determined that, in light of the importance 
of the Regulation's consumer protections and the significance of the 
continuing monetary harm to retirement investors without the rule's 
changes, an Applicability Date of April 10, 2017, is appropriate for 
plans and their affected service providers to adjust to the basic 
change from non-fiduciary to fiduciary status. This exemption has the 
same Applicability Date; parties may rely on it as of the Applicability 
Date.
    Section VII provides a transition period under which relief from 
the prohibited transaction provisions of ERISA and the Code is 
available for Financial Institutions and Advisers during the period 
between the Applicability Date and January 1, 2018 (the ``Transition 
Period''). For the Transition Period, full relief under the exemption 
will be available for Financial Institutions and Advisers subject to 
more limited conditions than the full set of conditions described 
above. This period is intended to provide Financial Institutions and 
Advisers time to prepare for compliance with the conditions of Section 
II-IV set forth above, while safeguarding the interests of Retirement 
Investors. The Transition Period conditions set forth in Section VII 
are subject to the same exclusions in Section I(c), for advice from 
fiduciaries with discretionary authority over the customer's 
investments and specified advice concerning in-house plans.
    The transitional conditions of Section VII require the Financial 
Institution and its Advisers to comply with the Impartial Conduct 
Standards when making recommendations regarding principal transactions 
and riskless principal transactions to Retirement Investors. The 
Impartial Conduct Standards required in Section VII are the same as 
required in Section II(c) but are repeated for ease of use.
    During the Transition Period, the Financial Institution must 
additionally provide a written notice to the Retirement Investor prior 
to or at the same time as the execution of the principal transaction or 
riskless principal transaction, which may cover multiple transactions 
or all transactions taking place within the Transition Period, 
affirmatively stating its and its Adviser(s) fiduciary status under 
ERISA or the Code or both with respect to the recommendation. The 
Financial Institution must also state in writing that it and its 
Advisers will comply with the Impartial Conduct Standards. Further, the 
Financial Institution's notice must disclose the circumstances under 
which the Adviser and Financial Institution may engage in principal 
transactions and riskless principal transactions with the Plan, 
participant or beneficiary account or IRA, and its Material Conflicts 
of Interest. The disclosure may be provided in person, electronically 
or by mail, and it may be provided in the same document as the

[[Page 21128]]

notice required in the transition period for exemption in Section IX of 
the Best Interest Contract Exemption.
    Similar to the disclosure provisions of Section II(e), the 
transitional exemption in Section VII provides for exemptive relief to 
continue despite errors and omissions in the disclosures, if the 
Financial Institution acts in good faith and with reasonable diligence.
    In addition, the Financial Institution must designate a person or 
persons, identified by name, title or function, responsible for 
addressing Material Conflicts of Interest and monitoring Advisers' 
adherence to the Impartial Conduct Standards.
    Finally, the Financial Institution must comply with the 
recordkeeping provision of Section V(a) and (b) of the exemption 
regarding the transactions entered into during the Transition Period.
    After the Transition Period, however, the exemption provided in 
Section VII will no longer be available. After that date, Financial 
Institutions and Advisers must satisfy all of the applicable conditions 
described in Sections II-V for the relief in Section I(b) to be 
available for any prohibited transactions occurring after that date. 
This includes the requirement to enter into a contract with a 
Retirement Investor, where required. Financial Institutions relying on 
the negative consent procedure set forth in Section II(a)(1)(ii) must 
provide the contractual provisions to Retirement Investors with 
Existing Contracts prior to January 1, 2018, and allow those Retirement 
Investors 30 days to terminate the contract. If the Retirement Investor 
does terminate the contract within that 30-day period, this exemption 
will provide relief for 14 days after the date on which the termination 
is received by the Financial Institution.
    The proposed exemption, with the proposed Best Interest Contract 
Exemption, the proposed Regulation and other exemption proposals, 
generally set forth an Applicability Date of eight months, although the 
proposals sought comment on a phase in of conditions. As with other 
sections of this preamble, the Department is addressing comments 
regarding the Applicability Date as a cohesive whole. Some commenters, 
concerned about the ongoing harm to Retirement Investors, urged the 
Department to implement the Regulation and related exemptions quickly. 
However, the majority of industry commenters requested a two- to three-
year transition period. These commenters requested time to enter into 
contracts with Retirement Investors (including developing and 
implementing the policies and procedures and incentive practices that 
meet the terms of Section II(d)). Some commenters requested the 
Department allow good faith compliance during the transition period. 
Others requested the Department phase in the requirements over time. 
One commenter requested the Best Interest standard become effective 
immediately, with the other conditions becoming effective within one 
year. Another comment expressed concern about phasing in the conditions 
over time, referring to this as a ``piecemeal'' approach, which would 
not be helpful to implementing a system to protect Retirement 
Investors. Other commenters wrote that the Department should re-propose 
the exemption or adopt it as an interim final exemption and seek 
additional comments.
    The transition provisions in Section VII of the final exemption 
respond to commenters' concerns about ongoing economic harm to 
Retirement Investors during the period in which Financial Institutions 
develop systems to comply with the exemption. The provisions require 
prompt implementation of certain core protections of the exemption in 
the form of the acknowledgment of fiduciary status, compliance with the 
Impartial Conduct Standards, and certain important disclosures, to 
safeguard Retirement Investors' interests. The provisions recognize, 
however, that the Financial Institutions will need time to develop 
policies and procedures and supervisory structures that fully comport 
with the requirements of the final exemption. Accordingly, during the 
Transition Period, Financial Institutions are not required to execute 
the contract or give Retirement Investors warranties or disclosures on 
their anti-conflict policies and procedures. While the Department 
expects that Advisers and Financial Institutions will, in fact, adopt 
prudent supervisory mechanisms to prevent violations of the Impartial 
Conduct Standards (and potential liability for such violations), the 
exemption will not require the Financial Institutions to make specific 
representations on the nature or quality of the policies and procedures 
during this Transition Period. The Department will be available to 
respond to Financial Institutions' request for guidance during this 
period, as they develop the systems necessary to comply with the 
exemption's conditions.
    The transition provisions also accommodate Financial Institutions' 
need for time to prepare for full compliance with the exemption, and 
therefore full compliance with all the final exemption's applicable 
conditions is delayed until January 1, 2018. The Department selected 
that period, rather than two to three years, as requested by some 
commenters, in light of the significant adjustments in the final 
exemption that significantly eased compliance burdens. Although the 
Department believes that the conditions of the exemption set forth in 
Section II-V are required to support the Department's findings required 
under ERISA section 408(a), and Code section 4975(c)(2) over the long 
term, the Department recognizes that Financial Institutions may need 
time to achieve full compliance with these conditions. The Department 
therefore finds that the provisions set forth in Section VII satisfy 
the criteria of ERISA section 408(a) and Code section 4975(c)(2) for 
the transition period because they provide the significant protections 
to Retirement Investors while providing Financial Institutions with 
time necessary to achieve full compliance. A similar transition period 
is provided for the companion Best Interest Contract Exemption due to 
the corresponding provisions in that exemption that may require time 
for Financial Institutions to begin compliance.
    The Department considered, but did not elect, delaying the 
application of the rule defining fiduciary investment advice until such 
time as Financial Institutions could make the changes to their 
practices and compensation structures necessary to comply with Sections 
II through V of this exemption. The Department believed that delaying 
the application of the new fiduciary rule would inordinately delay the 
basic protections of loyalty and prudence that the rule provides. 
Moreover, a long period of delay could incentivize Financial 
Institutions to increase efforts to provide conflicted advice to 
Retirement Investors before it becomes subject to the new rule. The 
Department understands that many of the concerns regarding the 
applicability date of the rule are related to the prohibited 
transaction provisions of ERISA and the Code rather than the basic 
fiduciary standards. This transition period exemption addresses these 
concerns by giving Financial Institutions and Advisers necessary time 
to fully comply with Sections II-V of the exemption.
    The Department also considered the views of commenters that 
requested re-proposal of the Regulation and exemptions, or issuing the 
rule and exemptions as interim final rules with requests for additional 
comment. After reviewing all the comments on the 2015 proposal, which 
was itself a re-proposal, the Department has concluded that it is in a 
position to publish a final rule and

[[Page 21129]]

exemptions. It has carefully considered and responded to the 
significant issues raised in the comments in drafting the final rule 
and exemptions. Moreover, the Department has concluded that the 
difference between the final documents and the proposals are also 
responsive to the commenters' concerns and could be reasonably foreseen 
by affected parties.

No Relief From ERISA Section 406(a)(1)(C) or Code Section 4975(c)(1)(C) 
for the Provision of Services

    This exemption will not provide relief from a transaction 
prohibited by ERISA section 406(a)(1)(C), or from the taxes imposed by 
Code section 4975(a) and (b) by reason of Code section 4975(c)(1)(C), 
regarding the furnishing of goods, services or facilities between a 
plan and a party in interest. The provision of investment advice to a 
plan under a contract with a fiduciary is a service to the plan and 
compliance with this exemption will not relieve an Adviser or Financial 
Institution of the need to comply with ERISA section 408(b)(2), Code 
section 4975(d)(2), and applicable regulations thereunder.

Paperwork Reduction Act Statement

    In accordance with the requirements of the Paperwork Reduction Act 
of 1995 (PRA) (44 U.S.C. 3506(c)(2)), the Department solicited comments 
on the information collections included in the proposed Exemption for 
Principal Transactions in Certain Debt Securities Between Investment 
Advice Fiduciaries and Employee Benefit Plans and IRAs. 80 FR 21989 
(Apr. 20, 2015). The Department also submitted an information 
collection request (ICR) to OMB in accordance with 44 U.S.C. 3507(d), 
contemporaneously with the publication of the proposal, for OMB's 
review. The Department received two comments from one commenter that 
specifically addressed the paperwork burden analysis of the information 
collections. Additionally many comments were submitted, described 
elsewhere in this preamble and in the preamble to the accompanying 
final rule, which contained information relevant to the costs and 
administrative burdens attendant to the proposals. The Department took 
into account such public comments in connection with making changes to 
the prohibited transaction exemption, analyzing the economic impact of 
the proposals, and developing the revised paperwork burden analysis 
summarized below.
    In connection with publication of this prohibited transaction 
exemption, the Department is submitting an ICR to OMB requesting 
approval of a new collection of information under OMB Control Number 
1210-0157. The Department will notify the public when OMB approves the 
ICR.
    A copy of the ICR may be obtained by contacting the PRA addressee 
shown below or at http://www.RegInfo.gov. PRA ADDRESSEE: G. Christopher 
Cosby, Office of Policy and Research, U.S. Department of Labor, 
Employee Benefits Security Administration, 200 Constitution Avenue NW., 
Room N-5718, Washington, DC 20210. Telephone: (202) 693-8410; Fax: 
(202) 219-4745. These are not toll-free numbers.
    As discussed in detail below, the class exemption will permit 
principal transactions and riskless principal transactions in certain 
principal traded assets between a plan, participant or beneficiary 
account, or an IRA, and an Adviser or Financial Institution, and the 
receipt of a mark-up or mark-down or other payment by the Adviser or 
Financial Institution for themselves or Affiliates as a result of 
investment advice. The class exemption will require Financial 
Institutions to enter into a contractual arrangement with Retirement 
Investors regarding principal transactions and riskless principal 
transactions with IRAs and plans not subject to Title I of ERISA (non-
ERISA plans), adopt written policies and procedures, make disclosures 
to Retirement Investors (including with respect to ERISA plans), and on 
a publicly available Web site, and maintain records necessary to prove 
that the conditions of the exemption have been met for a period of six 
(6) years from the date of each principal transaction or riskless 
principal transaction. In addition, the exemption provides a transition 
period from the Applicability Date, to January 1, 2018. As a condition 
of relief during the transition period, Financial Institutions must 
make a disclosure (transition disclosure) to all Retirement Investors 
(in ERISA plans, IRAs, and non-ERISA plans) prior to or at the same 
time as the execution of recommended transactions. These requirements 
are ICRs subject to the PRA.
    The Department has made the following assumptions in order to 
establish a reasonable estimate of the paperwork burden associated with 
these ICRs:
     51.8 percent of disclosures to Retirement Investors with 
respect to ERISA plans \70\ and 44.1 percent of contracts with and 
disclosures to Retirement Investors with respect to IRAs and non-ERISA 
plans \71\ will be distributed electronically via means already used by 
respondents in the normal course of business and the costs arising from 
electronic distribution will be negligible, while the remaining 
contracts and disclosures will be distributed on paper and mailed at a 
cost of $0.05 per page for materials and $0.49 for first class postage;
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    \70\ According to data from the National Telecommunications and 
Information Agency (NTIA), 33.4 percent of individuals age 25 and 
over have access to the internet at work. According to a Greenwald & 
Associates survey, 84 percent of plan participants find it 
acceptable to make electronic delivery the default option, which is 
used as the proxy for the number of participants who will not opt 
out that are automatically enrolled (for a total of 28.1 percent 
receiving electronic disclosure at work). Additionally, the NTIA 
reports that 38.9 percent of individuals age 25 and over have access 
to the internet outside of work. According to a Pew Research Center 
survey, 61 percent of internet users use online banking, which is 
used as the proxy for the number of internet users who will opt in 
for electronic disclosure (for a total of 23.7 percent receiving 
electronic disclosure outside of work). Combining the 28.1 percent 
who receive electronic disclosure at work with the 23.7 percent who 
receive electronic disclosure outside of work produces a total of 
51.8 percent who will receive electronic disclosure overall.
    \71\ According to data from the NTIA, 72.4 percent of 
individuals age 25 and older have access to the internet. According 
to a Pew Research Center survey, 61 percent of internet users use 
online banking, which is used as the proxy for the number of 
internet users who will opt in for electronic disclosure. Combining 
these data produces an estimate of 44.1 percent of individuals who 
will receive electronic disclosures.
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     Financial Institutions will use existing in-house 
resources to distribute required contracts and disclosures;
     Tasks associated with the ICRs performed by in-house 
personnel will be performed by clerical personnel at an hourly wage 
rate of $55.21;\72\
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    \72\ For a description of the Department's methodology for 
calculating wage rates, see http://www.dol.gov/ebsa/pdf/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-march-2016.pdf. The Department's methodology for calculating the overhead 
cost input of its wage rates was adjusted from the proposed PTE to 
the final PTE. In the proposed PTE, the Department based its 
overhead cost estimates on longstanding internal EBSA calculations 
for the cost of overhead. In response to a public comment stating 
that the overhead cost estimates were too low and without any 
supporting evidence, the Department incorporated published U.S. 
Census Bureau survey data on overhead costs into its wage rate 
estimates.
---------------------------------------------------------------------------

     Financial Institutions will hire outside service providers 
to assist with nearly all other compliance costs;
     Outsourced legal assistance will be billed at an hourly 
rate of $335.00;\73\
---------------------------------------------------------------------------

    \73\ This rate is the average of the hourly rate of an attorney 
with 4-7 years of experience and an attorney with 8-10 years of 
experience, taken from the Laffey Matrix. See http://www.justice.gov/sites/default/files/usao-dc/legacy/2014/07/14/Laffey%20Matrix_2014-2015.pdf
---------------------------------------------------------------------------

     Approximately 6,000 Financial Institutions \74\ will 
utilize the exemption

[[Page 21130]]

to engage in principal transactions and riskless principal 
transactions.
---------------------------------------------------------------------------

    \74\ One commenter questioned the basis for the Department's 
assumption regarding the number of Financial Institutions likely to 
use the exemption. According to the ``2015 Investment Management 
Compliance Testing Survey,'' Investment Adviser Association, cited 
in the regulatory impact analysis for the accompanying rule, 63 
percent of Registered Investment Advisers service ERISA-covered 
plans and IRAs. The Department conservatively interprets this to 
mean that all of the 113 large Registered Investment Advisers 
(RIAs), 63 percent of the 3,021 medium RIAs (1,903), and 63 percent 
of the 24,475 small RIAs (15,419) work with ERISA-covered plans and 
IRAs. The Department assumes that all of the 42 large broker-
dealers, and similar shares of the 233 medium broker-dealers (147) 
and the 3,682 small broker-dealers (2,320) work with ERISA-covered 
plans and IRAs. According to SEC and FINRA data, cited in the 
regulatory impact analysis, 18 percent of broker-dealers are also 
registered as RIAs. Removing these firms from the RIA counts 
produces counts of 105 large RIAs, 1,877 medium RIAs, and 15,001 
small RIAs that work with ERISA-covered plans and IRAs and are not 
also registered as broker-dealers. Further, according to Hung et al. 
(2008) (see Regulatory Impact Analysis for complete citation), 
approximately 13 percent of RIAs report receiving commissions. 
Additionally, 20 percent of RIAs report receiving performance based 
fees; however, at least 60 percent of these RIAs are likely to be 
hedge funds. Thus, as much as 8 percent of RIAs providing investment 
advice receive performance based fees. Combining the 8 percent of 
RIAs receiving performance based fees with the 13 percent of RIAs 
receiving commissions creates a conservative estimate of 21 percent 
of RIAs that might need exemptive relief. Although the Department 
believes that very few RIAs that are not also broker-dealers engage 
in principal transactions and riskless principal transactions, its 
data to support this belief is limited, so the Department is 
conservatively assuming that the same RIAs that receive performance-
based fees and commissions are the types of RIAs that might engage 
in principal transactions and riskless principal transactions. In 
total, the Department estimates that 2,509 broker-dealers and 3,566 
RIAs receiving performance-based fees and commissions will use this 
exemption. As described in detail in the regulatory impact analysis, 
the Department believes a de minimis number of banks may also use 
the exemption.
---------------------------------------------------------------------------

Compliance Costs for Financial Institutions

    The Department believes that nearly all Financial Institutions will 
contract with outside service providers to implement the various 
compliance requirements of this exemption. As described in the 
regulatory impact analysis, per-Financial Institution costs for broker-
dealers (BDs) were calculated by allocating the total cost reductions 
in the medium assumptions scenario across the Financial Institution 
size categories, and then subtracting the cost reductions from the per-
Financial Institution average costs derived from the Oxford Economics 
study. The methodology for calculating the per-Financial Institution 
costs for registered investment advisers (RIAs) is described in detail 
in the regulatory impact analysis. The Department is attributing 50 
percent of the compliance costs for BDs and RIAs to this Exemption and 
50 percent of the compliance costs for BDs and RIAs to the Best 
Interest Contract Exemption, published elsewhere in today's Federal 
Register. With the above assumptions, the per-Financial Institution 
costs are as follows:

 Start-Up Costs for Large BDs: $3.7 million
 Start-Up Costs for Large RIAs: $3.2 million
 Start-Up Costs for Medium BDs: $889,000
 Start-Up Costs for Medium RIAs: $662,000
 Start-Up Costs for Small BDs: $278,000
 Start-Up Costs for Small RIAs: $219,000
 Ongoing Costs for Large BDs: $918,000
 Ongoing Costs for Large RIAs: $803,000
 Ongoing Costs for Medium BDs: $192,000
 Ongoing Costs for Medium RIAs: $143,000
 Ongoing Costs for Small BDs: $60,000
 Ongoing Costs for Small RIAs: $47,000

    In order to engage in transactions and receive compensation covered 
under this exemption, Section II requires Financial Institutions to 
acknowledge, in writing, their fiduciary status and adopt written 
policies and procedures designed to ensure compliance with the 
Impartial Conduct Standards. Financial Institutions must make certain 
disclosures to Retirement Investors. Financial institutions must 
generally enter into a written contract with Retirement Investors with 
respect to principal transactions and riskless principal transactions 
with IRAs and non-ERISA plans with certain required provisions, 
including affirmative agreement to adhere to the Impartial Conduct 
Standards and, if they are FINRA members, to comply with FINRA rules 
2121 and 5310.
    Section IV requires Financial Institutions and Advisers to make 
certain disclosures to the Retirement Investor. These disclosures 
include: (1) A pre-transaction disclosure; (2) a disclosure, on demand, 
of information regarding the principal traded asset, including its 
salient attributes; (3) an annual disclosure; (4) transaction 
confirmations; and (5) a web-based disclosure.
    Section VII requires Financial Institutions to make a transition 
disclosure, acknowledging their fiduciary status and that of their 
Advisers with respect to the Advice, stating the Best Interest standard 
of care, and describing the circumstances under which principal 
transactions and riskless principal transactions may occur and the 
associated Material Conflicts of Interest, prior to engaging in any 
transactions during the transition period from the Applicability Date 
to January 1, 2018. The transition disclosure can cover multiple 
transactions, or all transactions occurring in the transition period.
    The Department is able to disaggregate an estimate of many of the 
legal costs from the costs above; however, it is unable to disaggregate 
any of the other costs. The Department received a comment on the 
proposed PTE stating that the estimates for legal professional time to 
draft disclosures were not supported by any empirical evidence. The 
Department also received multiple comments on the proposed PTE stating 
that its estimate of 60 hours of legal professional time during the 
first year a financial institution used the exemption and then no legal 
professional time in subsequent years was too low.
    In response to a recommendation made during the Department's August 
2015, public hearing on the proposed rule and exemptions, and in an 
attempt to create estimates with a clearer empirical evidentiary basis, 
the Department drafted certain portions of the required disclosures, 
including a sample contract, the one-time disclosure to the Department, 
and the transition disclosure. The Department believes that the time 
spent updating existing contracts and disclosures in future years would 
be no longer than the time necessary to create the original contracts 
and disclosures. The Department did not attempt to draft the complete 
set of required disclosures because it expects that the amount of time 
necessary to draft such disclosures will vary greatly among firms. For 
example, the Department did not attempt to draft sample policies and 
procedures, pre-transaction disclosures, disclosures regarding the 
principal traded assets, or confirmation slips. The Department expects 
the amount of time necessary to complete these disclosures will vary 
significantly based on a variety of factors including the nature of a 
firm's compensation structure, and the extent to which a firm's 
policies and procedures require review and signatures by different 
individuals. The Department further believes that pre-transaction 
disclosures will be provided orally at de minimis cost, facts and 
circumstances will vary too widely to accurately depict the disclosures 
regarding the principal traded assets, and providing confirmation slips 
is a regular and customary business practice

[[Page 21131]]

producing de minimis additional burden.
    Considered in conjunction with the estimates provided in the 
proposal, the Department estimates that outsourced legal assistance to 
draft standard contracts, contract disclosures, annual disclosures, and 
transition disclosures will cost an average of $3,676 per Financial 
Institution for a total of $22.3 million during the first year. In 
subsequent years, it will cost an average of $2,978 per Financial 
Institution for a total of $18.1 million annually to update the 
contracts, contract disclosures, and annual disclosures.
    The legal costs of these disclosures were disaggregated from the 
total compliance costs because these disclosures are expected to be 
relatively uniform. Although the tested disclosures generally took less 
time than many of the commenters said they would, the Department 
acknowledges that the disclosures that were not tested are those that 
are expected to be the most time consuming. Importantly, as explained 
in greater detail in section 5.3 of the regulatory impact analysis, the 
Department is primarily relying on cost data provided by the Securities 
Industry and Financial Markets Association (SIFMA) and the Financial 
Services Institute (FSI) to calculate the total cost of the legal 
disclosures, rather than its own internal drafting of disclosures. 
Accordingly, in the event that any of the Department's estimates 
understate the time necessary to create and update the disclosures, it 
does not impact the total burden estimates. The total burden estimates 
were derived from SIFMA and FSI's all-inclusive costs. Therefore, in 
the event that legal costs are understated, other cost estimates in 
this analysis would be overstated in an equal manner.
    In addition to legal costs for creating the contracts and 
disclosures, the start-up cost estimates include the costs of 
implementing and updating the IT infrastructure, creating the web 
disclosures, gathering and maintaining the records necessary to produce 
the various disclosures, developing policies and procedures, addressing 
material conflicts of interest, monitoring Advisers' adherence to the 
Impartial Conduct Standards, and any other steps necessary to ensure 
compliance with the conditions of the Exemption not described 
elsewhere. In addition to legal costs for updating the contracts and 
disclosures, the ongoing cost estimates include the costs of updating 
the IT infrastructure, updating the web disclosures, reviewing 
processes for gathering and maintaining the records necessary to 
produce the various disclosures, reviewing the policies and procedures, 
producing the detailed disclosures regarding principal traded assets on 
request, monitoring investments as agreed upon with the Retirement 
Investor, addressing material conflicts of interest, monitoring 
Advisers' adherence to the Impartial Conduct Standards, and any other 
steps necessary to ensure compliance with the conditions of the 
exemption not described elsewhere. These costs total $1.9 billion 
during the first year and $412.2 million in subsequent years. These 
costs do not include the costs of producing of distributing disclosures 
and contracts, which are discussed below.

Distribution of Disclosures and Contracts

    The Department estimates that 14,000 Retirement Investors with 
respect to ERISA plans and 2.4 million Retirement Investors with 
respect to IRAs and non-ERISA plans will receive a three-page 
transition disclosure during the first year. Additionally, 14,000 
Retirement Investors with respect to ERISA plans will receive a 
fifteen-page contract disclosure, and 2.4 million Retirement Investors 
with respect to IRAs and non-ERISA plans will receive a fifteen-page 
contract during the first year. In subsequent years, 4,000 Retirement 
Investors with respect to ERISA plans will receive a fifteen-page 
contract disclosure and 490,000 Retirement Investors with respect to 
IRAs and non-ERISA plans will receive a fifteen-page contract. To the 
extent that Financial Institutions use both the Best Interest Contract 
Exemption and the Principal Transactions Exemption, these estimates may 
represent overestimates because significant overlap exists between the 
requirements of the transition disclosure and the contract for both 
exemptions. If Financial Institutions choose to use both exemptions 
with the same clients, they will probably combine the documents.
    The transition disclosure will be distributed electronically to 
51.8 percent of ERISA plan investors and 44.1 percent of IRAs and non-
ERISA plan investors during the first year. Paper disclosures will be 
mailed to the remaining 48.2 percent of ERISA plan investors and 55.9 
percent of IRAs and non-ERISA plan investors. The contract disclosure 
will be distributed electronically to 51.8 percent of the ERISA plan 
investors during the first year or during any subsequent year in which 
the plan investor begins a new advisory relationship. Paper contract 
disclosures will be mailed to 48.2 percent of ERISA plan investors. The 
contract will be distributed electronically to 44.1 percent of IRAs and 
non-ERISA plan participants during the first year or during any 
subsequent year in which the investor begins a new advisory 
relationship. Paper contracts will be mailed to 55.9 percent of IRAs 
and non-ERISA plan investors. The Department estimates that electronic 
distribution will result in de minimis cost, while paper distribution 
will cost approximately $2.5 million during the first year and $342,000 
during subsequent years. Paper distribution will also require two 
minutes of clerical time to print and mail the disclosure or 
contract,\75\ resulting in 85,000 hours at an equivalent cost of $4.7 
million during the first year and 9,000 hours at an equivalent cost of 
$508,000 during subsequent years.
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    \75\ One commenter questioned the basis for this estimate. The 
Department worked with clerical staff to determine that most notices 
and disclosures can be printed and prepared for mailing in less than 
one minute per disclosure. Therefore, an estimate of two minutes per 
disclosure is a conservative estimate.
---------------------------------------------------------------------------

    The Department estimates that 2.5 million Retirement Investors for 
ERISA plans, IRAs and non-ERISA plans will receive a two-page annual 
disclosure during the second year and all subsequent years. The 
disclosure will be distributed electronically to 51.8 percent of ERISA 
plan investors and 44.1 percent of IRA holders and non-ERISA plan 
investors. Paper statements will be mailed to 48.2 percent of ERISA 
plan investors and 55.9 percent of IRA owners and non-ERISA plan 
participants. The Department estimates that electronic distribution 
will result in de minimis cost, while paper distribution will cost 
approximately $812,000.\76\ Paper distribution will also require two 
minutes of clerical time to print and mail the statement, resulting in 
46,000 hours at an equivalent cost of $2.5 million annually.
---------------------------------------------------------------------------

    \76\ This cost includes $0.05 per page for materials and $0.49 
per mailing for postage.
---------------------------------------------------------------------------

    The Department estimates that Financial Institutions will receive 
ten requests per year for more detailed principal traded asset 
information during the second year and all subsequent years. The 
detailed disclosures will be distributed electronically for 51.8 
percent of the ERISA plan investors and 44.1 percent of the IRA holders 
and non-ERISA plan participants. The Department believes that requests 
for additional information will be proportionally likely with each 
Retirement Investor type. Therefore, approximately 34,000 detailed 
disclosures will be distributed on paper. The Department estimates that 
electronic distribution will result in de minimis cost, while paper 
distribution

[[Page 21132]]

will cost approximately $25,000. Paper distribution will also require 
two minutes of clerical time to print and mail the statement, resulting 
in 1,000 hours at an equivalent cost of $62,000 annually.

Overall Summary

    Overall, the Department estimates that in order to meet the 
conditions of this Exemption, Financial Institutions and Advisers will 
distribute approximately 4.9 million disclosures and contracts during 
the first year and 3.0 million disclosures and contracts during 
subsequent years. Distributing these disclosures and contracts will 
result in a total of 85,000 hours of burden during the first year and 
56,000 hours of burden in subsequent years. The equivalent cost of this 
burden is $4.7 million during the first year and $3.1 million in 
subsequent years. This exemption will result in an outsourced labor, 
materials, and postage cost burden of $2.0 billion during the first 
year and $431.5 million during subsequent years.
    These paperwork burden estimates are summarized as follows:
    Type of Review: New collection.
    Agency: Employee Benefits Security Administration, Department of 
Labor.
    Titles: (1) Prohibited Transaction Exemption for Principal 
Transactions in Certain Assets between Investment Advice Fiduciaries 
and Employee Benefit Plans and IRAs and (2) Final Investment Advice 
Regulation.
    OMB Control Number: 1210-0157.
    Affected Public: Businesses or other for-profits; not for profit 
institutions.
    Estimated Number of Respondents: 6,075.
    Estimated Number of Annual Responses: 4,927,605 during the first 
year and 3,018,574 during subsequent years.
    Frequency of Response: When engaging in exempted transaction; 
Annually.
    Estimated Total Annual Burden Hours: 85,457 hours during the first 
year and 56,197 hours in subsequent years.
    Estimated Total Annual Burden Cost: $1,956,129,694 during the first 
year and $431,468,619 in subsequent years.

Regulatory Flexibility Act

    This exemption, which is issued pursuant to ERISA section 408(a) 
and Code section 4975(c)(2), is part of a broader rulemaking that 
includes other exemptions and a final regulation published in today's 
Federal Register. The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) 
imposes certain requirements with respect to Federal rules that are 
subject to the notice and comment requirements of section 553(b) of the 
Administrative Procedure Act (5 U.S.C. 551 et seq.), or any other laws. 
Unless the head of an agency certifies that a final rule is not likely 
to have a significant economic impact on a substantial number of small 
entities, section 604 of the RFA requires that the agency present a 
final regulatory flexibility analysis (FRFA) describing the rule's 
impact on small entities and explaining how the agency made its 
decisions with respect to the application of the rule to small 
entities.
    The Secretary has determined that this rulemaking, including this 
exemption, will have a significant economic impact on a substantial 
number of small entities. The Secretary has separately published a 
Regulatory Impact Analysis (RIA) which contains the complete economic 
analysis for this rulemaking including the Department's FRFA for the 
rule and the related prohibited transaction exemptions. This section of 
this preamble sets forth a summary of the FRFA. The RIA is available at 
www.dol.gov/ebsa.
    As noted in section 6.1 of the RIA, the Department has determined 
that regulatory action is needed to mitigate conflicts of interest in 
connection with investment advice to Retirement Investors. The 
Regulation is intended to improve plan and IRA investing to the benefit 
of retirement security. In response to the proposed rulemaking, 
organizations representing small businesses submitted comments 
expressing particular concern with three issues: the carve-out for 
investment education, the Best Interest Contract Exemption, and the 
carve-out for persons acting in the capacity of counterparties to plan 
fiduciaries with financial expertise. Section 2 of the RIA contains an 
extensive discussion of these concerns and the Department's response.
    As discussed in section 6.2 of the RIA, the Small Business 
Administration (SBA) defines a small business in the Financial 
Investments and Related Activities Sector as a business with up to 
$38.5 million in annual receipts. In response to a comment received 
from the SBA's Office of Advocacy on our Initial Regulatory Flexibility 
Analysis, the Department contacted the SBA, and received from them a 
dataset containing data on the number of Financial Institutions by 
NAICS codes, including the number of Financial Institutions in given 
revenue categories. This dataset would allow the estimation of the 
number of Financial Institutions with a given NAICS code that fall 
below the $38.5 million threshold and therefore be considered small 
entities by the SBA. However, this dataset alone does not provide a 
sufficient basis for the Department to estimate the number of small 
entities affected by the rule. Not all Financial Institutions within a 
given NAICS code would be affected by this rule, because being an ERISA 
fiduciary relies on a functional test and is not based on industry 
status as defined by a NAICS code. Further, not all Financial 
Institutions within a given NAICS code work with ERISA-covered plans 
and IRAs.
    Over 90 percent of broker-dealers, registered investment advisers, 
insurance companies, agents, and consultants are small businesses 
according to the SBA size standards (13 CFR 121.201). Applying the 
ratio of entities that meet the SBA size standards to the number of 
affected entities, based on the methodology described at greater length 
in the RIA, the Department estimates that the number of small entities 
affected by this rule is 2,438 BDs, 16,521 RIAs, 496 Insurers, and 
3,358 other ERISA service providers.
    For purposes of the RFA, the Department continues to consider an 
employee benefit plan with fewer than 100 participants to be a small 
entity. Further, while some large employers may have small plans, in 
general small employers maintain most small plans. The definition of 
small entity considered appropriate for this purpose differs, however, 
from a definition of small business that is based on size standards 
promulgated by the SBA. These small pension plans will benefit from the 
rule, because as a result of the rule, they will receive non-conflicted 
advice from their fiduciary service providers. The 2013 Form 5500 
filings show nearly 595,000 ERISA covered retirement plans with less 
than 100 participants.
    Section 6.5 of the RIA summarizes the projected reporting, 
recordkeeping, and other compliance costs of the rule and exemptions, 
which are discussed in detail in section 5 of the RIA. Among other 
things, the Department concludes that it is likely that some small 
service providers may find that the increased costs associated with 
ERISA fiduciary status outweigh the benefits of continuing to service 
the ERISA plan market or the IRA market. The Department does not 
believe that this outcome will be widespread or that it will result in 
a diminution of the amount or quality of advice available to small or 
other retirement savers, because some Financial Institutions will fill 
the void and provide services the ERISA plan and IRA market. It is also 
possible that the economic impact of the

[[Page 21133]]

rule and exemptions on small entities would not be as significant as it 
would be for large entities, because anecdotal evidence indicates that 
small entities do not have as many business arrangements that give rise 
to conflicts of interest. Therefore, they would not be confronted with 
the same costs to restructure transactions that would be faced by large 
entities.
    Section 5.3.1 of the RIA includes a discussion of the changes to 
the proposed rule and exemptions that are intended to reduce the costs 
affecting both small and large business. These include elimination of 
data collection and annual disclosure requirements in the Best Interest 
Contract Exemption, and changes to the implementation of the contract 
requirement in the exemption. Section 7 of the RIA discusses 
significant regulatory alternatives considered by the Department and 
the reasons why they were rejected.

Congressional Review Act

    This exemption, along with related exemptions and a final rule 
published elsewhere in this issue of the Federal Register, is part of a 
rulemaking that is subject to the Congressional Review Act provisions 
of the Small Business Regulatory Enforcement Fairness Act of 1996 (5 
U.S.C. 801, et seq.) and, will be transmitted to Congress and the 
Comptroller General for review. This rulemaking, including this 
exemption is treated as a ``major rule'' as that term is defined in 5 
U.S.C. 804, because it is likely to result in an annual effect on the 
economy of $100 million or more.

General Information

    The attention of interested persons is directed to the following:
    (1) The fact that a transaction is the subject of an exemption 
under ERISA section 408(a) and Code section 4975(c)(2) does not relieve 
a fiduciary or other party in interest or disqualified person with 
respect to a plan or IRA from certain other provisions of ERISA and the 
Code, including any prohibited transaction provisions to which the 
exemption does not apply and the general fiduciary responsibility 
provisions of ERISA section 404 which require, among other things, that 
a fiduciary act prudently and discharge his or her duties respecting 
the plan solely in the interests of the participants and beneficiaries 
of the plan. Additionally, the fact that a transaction is the subject 
of an exemption does not affect the requirement of Code section 401(a) 
that the plan must operate for the exclusive benefit of the employees 
of the employer maintaining the plan and their beneficiaries;
    (2) The Department finds that the exemption is administratively 
feasible, in the interests of the plan and of its participants and 
beneficiaries, and protective of the rights of participants and 
beneficiaries of the plan;
    (3) The exemption is applicable to a particular transaction only if 
the transaction satisfies the conditions specified in the exemption; 
and
    (4) The exemption is supplemental to, and not in derogation of, any 
other provisions of ERISA and the Code, including statutory or 
administrative exemptions and transitional rules. Furthermore, the fact 
that a transaction is subject to an administrative or statutory 
exemption is not dispositive of whether the transaction is in fact a 
prohibited transaction.

Exemption

Section I--Exemption

    (a) In general. ERISA and the Internal Revenue Code prohibit 
fiduciary advisers to employee benefit plans (Plans) and individual 
retirement plans (IRAs) from self-dealing, including receiving 
compensation that varies based on their investment recommendations. 
ERISA and the Code also prohibit fiduciaries from engaging in 
securities purchases and sales with Plans or IRAs on behalf of their 
own accounts (Principal Transactions). This exemption permits certain 
persons who provide investment advice to Retirement Investors (i.e., 
fiduciaries of Plans, Plan participants or beneficiaries, or IRA 
owners) to engage in certain Principal Transactions and Riskless 
Principal Transactions as described below.
    (b) Exemption. This exemption permits an Adviser or Financial 
Institution to engage in the purchase or sale of a Principal Traded 
Asset in a Principal Transaction or Riskless Principal Transaction with 
a Plan, participant or beneficiary account, or IRA, and receive a mark-
up, mark-down or other similar payment as applicable to the transaction 
for themselves or any Affiliate, as a result of the Adviser's and 
Financial Institution's advice regarding the Principal Transaction or 
Riskless Principal Transaction. As detailed below, Financial 
Institutions and Advisers seeking to rely on the exemption must 
acknowledge fiduciary status, adhere to Impartial Conduct Standards in 
rendering advice, disclose Material Conflicts of Interest associated 
with Principal Transactions and Riskless Principal Transactions and 
obtain the consent of the Plan or IRA. In addition, Financial 
Institutions must adopt certain policies and procedures, including 
policies and procedures reasonably designed to ensure that individual 
Advisers adhere to the Impartial Conduct Standards; and retain certain 
records. This exemption provides relief from ERISA section 406(a)(1)(A) 
and (D) and section 406(b)(1) and (2), and the taxes imposed by Code 
section 4975(a) and (b), by reason of Code section 4975(c)(1)(A), (D), 
and (E). The Adviser and Financial Institution must comply with the 
conditions of Sections II-V.
    (c) Scope of this exemption: This exemption does not apply if:
    (1) The Adviser: (i) Has or exercises any discretionary authority 
or discretionary control respecting management of the assets of the 
Plan, participant or beneficiary account, or IRA involved in the 
transaction or exercises any discretionary authority or control 
respecting management or the disposition of the assets; or (ii) has any 
discretionary authority or discretionary responsibility in the 
administration of the Plan, participant or beneficiary account, or IRA; 
or
    (2) The Plan is covered by Title I of ERISA and (i) the Adviser, 
Financial Institution or any Affiliate is the employer of employees 
covered by the Plan, or (ii) the Adviser or Financial Institution is a 
named fiduciary or plan administrator (as defined in ERISA section 
3(16)(A)) with respect to the Plan, or an Affiliate thereof, that was 
selected to provide investment advice to the plan by a fiduciary who is 
not Independent.

Section II--Contract, Impartial Conduct, and Other Conditions

    The conditions set forth in this section include certain Impartial 
Conduct Standards, such as a Best Interest standard, that Advisers and 
Financial Institutions must satisfy to rely on the exemption. In 
addition, this section requires Financial Institutions to adopt anti-
conflict policies and procedures that are reasonably designed to ensure 
that Advisers adhere to the Impartial Conduct Standards, and requires 
disclosure of important information about the Principal Transaction or 
Riskless Principal Transaction. With respect to IRAs and Plans not 
covered by Title I of ERISA, the Financial Institutions must agree that 
they and their Advisers will adhere to the exemption's standards in a 
written contract that is enforceable by the Retirement Investors. To 
minimize compliance burdens, the exemption provides that the contract 
terms may be incorporated into account opening

[[Page 21134]]

documents and similar commonly-used agreements with new customers, and 
the exemption permits reliance on a negative consent process with 
respect to existing contract holders. The contract does not need to be 
executed before the provision of advice to the Retirement Investor to 
engage in a Principal Transaction or Riskless Principal Transaction. 
However, the contract must cover any advice given prior to the contract 
date in order for the exemption to apply to such advice. There is no 
contract requirement for recommendations to Retirement Investors about 
investments in Plans covered by Title I of ERISA, but the Impartial 
Conduct Standards and other requirements of Section II(b)-(e) must be 
satisfied in order for relief to be available under the exemption, as 
set forth in Section II(g). Section II(a) imposes the following 
conditions on Financial Institutions and Advisers:
    (a) Contracts with Respect to Principal Transactions and Riskless 
Principal Transactions Involving IRAs and Plans Not Covered by Title I 
of ERISA. If the investment advice resulting in the Principal 
Transaction or Riskless Principal Transaction concerns an IRA or a Plan 
that is not covered by Title I, the advice is subject to an enforceable 
written contract on the part of the Financial Institution, which may be 
a master contract covering multiple recommendations, that is entered 
into in accordance with this Section II(a) and incorporates the terms 
set forth in Section II(b)-(d). The Financial Institution additionally 
must provide the disclosures required by Section II(e). The contract 
must cover advice rendered prior to the execution of the contract in 
order for the exemption to apply to such advice and related 
compensation.
    (1) Contract Execution and Assent.
    (i) New Contracts. Prior to or at the same time as the execution of 
the Principal Transaction or Riskless Principal Transaction, the 
Financial Institution enters into a written contract with the 
Retirement Investor acting on behalf of the Plan, participant or 
beneficiary account, or IRA, incorporating the terms required by 
Section II(b)-(d). The terms of the contract may appear in a standalone 
document or they may be incorporated into an investment advisory 
agreement, investment program agreement, account opening agreement, 
insurance or annuity contract or application, or similar document, or 
amendment thereto. The contract must be enforceable against the 
Financial Institution. The Retirement Investor's assent to the contract 
may be evidenced by handwritten or electronic signatures.
    (ii) Amendment of Existing Contracts by Negative Consent. As an 
alternative to executing a contract in the manner set forth in the 
preceding paragraph, the Financial Institution may amend Existing 
Contracts to include the terms required in Section II(b)-(d) by 
delivering the proposed amendment and the disclosure required by 
Section II(e) to the Retirement Investor prior to January 1, 2018, and 
considering the failure to terminate the amended contract within 30 
days as assent. An Existing Contract is an investment advisory 
agreement, investment program agreement, account opening agreement, 
insurance contract, annuity contract, or similar agreement or contract 
that was executed before January 1, 2018, and remains in effect. If the 
Financial Institution elects to use the negative consent procedure, it 
may deliver the proposed amendment by mail or electronically, provided 
such means is reasonably calculated to result in the Retirement 
Investor's receipt of the proposed amendment, but it may not impose any 
new contractual obligations, restrictions, or liabilities on the 
Retirement Investor by negative consent.
    (2) Notice. The Financial Institution maintains an electronic copy 
of the Retirement Investor's contract on the Financial Institution's 
Web site that is accessible by the Retirement Investor.
    (b) Fiduciary. The Financial Institution affirmatively states in 
writing that the Financial Institution and the Adviser(s) act as 
fiduciaries under ERISA or the Code, or both, with respect to any 
investment advice regarding Principal Transactions and Riskless 
Principal Transactions provided by the Financial Institution or the 
Adviser subject to the contract, or in the case of an ERISA Plan, with 
respect to any investment advice regarding Principal Transactions and 
Riskless Principal Transactions between the Financial Institution and 
the Plan or participant or beneficiary account.
    (c) Impartial Conduct Standards. The Financial Institution states 
that it and its Advisers agree to adhere to the following standards 
and, they in fact, comply with the standards:
    (1) When providing investment advice to a Retirement Investor 
regarding the Principal Transaction or Riskless Principal Transaction, 
the Financial Institution and Adviser provide investment advice that 
is, at the time of the recommendation, in the Best Interest of the 
Retirement Investor. As further defined in Section VI(c), such advice 
reflects the care, skill, prudence, and diligence under the 
circumstances then prevailing that a prudent person acting in a like 
capacity and familiar with such matters would use in the conduct of an 
enterprise of a like character and with like aims, based on the 
investment objectives, risk tolerance, financial circumstances, and 
needs of the Retirement Investor, without regard to the financial or 
other interests of the Adviser, Financial Institution, or any Affiliate 
or other party;
    (2) The Adviser and Financial Institution seek to obtain the best 
execution reasonably available under the circumstances with respect to 
the Principal Transaction or Riskless Principal Transaction.
    (i) Financial Institutions that are FINRA members shall satisfy 
this Section II(c)(2) if they comply with the terms of FINRA rules 2121 
(Fair Prices and Commissions) and 5310 (Best Execution and 
Interpositioning), or any successor rules in effect at the time of the 
transaction, as interpreted by FINRA, with respect to the Principal 
Transaction or Riskless Principal Transaction.
    (ii) The Department may identify specific requirements regarding 
best execution and/or fair prices imposed by another regulator or self-
regulatory organization relating to additional Principal Traded Assets 
pursuant to Section VI(j)(1)(iv) in an individual exemption that may be 
satisfied as an alternative to the standard set forth in Section 
II(c)(2) above.
    (3) Statements by the Financial Institution and its Advisers to the 
Retirement Investor about the Principal Transaction or Riskless 
Principal Transaction, fees and compensation related to the Principal 
Transaction or Riskless Principal Transaction, Material Conflicts of 
Interest, and any other matters relevant to a Retirement Investor's 
decision to engage in the Principal Transaction or Riskless Principal 
Transaction, will not be materially misleading at the time they are 
made.
    (d) Warranty. The Financial Institution affirmatively warrants, and 
in fact complies with, the following:
    (1) The Financial Institution has adopted and will comply with 
written policies and procedures reasonably and prudently designed to 
ensure that its individual Advisers adhere to the Impartial Conduct 
Standards set forth in Section II(c);
    (2) In formulating its policies and procedures, the Financial 
Institution has specifically identified and documented its Material 
Conflicts of Interest associated with Principal Transactions and 
Riskless Principal Transactions;

[[Page 21135]]

adopted measures reasonably and prudently designed to prevent Material 
Conflicts of Interest from causing violations of the Impartial Conduct 
Standards set forth in Section II(c); and designated a person or 
persons, identified by name, title or function, responsible for 
addressing Material Conflicts of Interest and monitoring Advisers' 
adherence to the Impartial Conduct Standards;
    (3) The Financial Institution's policies and procedures require 
that neither the Financial Institution nor (to the best of the 
Financial Institution's knowledge) any Affiliate uses or relies on 
quotas, appraisals, performance or personnel actions, bonuses, 
contests, special awards, differential compensation or other actions or 
incentives that are intended or would reasonably be expected to cause 
individual Advisers to make recommendations regarding Principal 
Transactions and Riskless Principal Transactions that are not in the 
Best Interest of the Retirement Investor. Notwithstanding the 
foregoing, the requirement of this Section II(d)(3) does not prevent 
the Financial Institution or its Affiliates from providing Advisers 
with differential compensation (whether in type or amount, and 
including, but not limited to, commissions) based on investment 
decisions by Plans, participant or beneficiary accounts, or IRAs, to 
the extent that the policies and procedures and incentive practices, 
when viewed as a whole, are reasonably and prudently designed to avoid 
a misalignment of the interests of Advisers with the interests of the 
Retirement Investors they serve as fiduciaries;
    (4) The Financial Institution's written policies and procedures 
regarding Principal Transactions and Riskless Principal Transactions 
address how credit risk and liquidity assessments for Debt Securities, 
as required by Section III(a)(3), will be made.
    (e) Transaction Disclosures. In the contract, or in a separate 
single written disclosure provided to the Retirement Investor or Plan 
prior to or at the same time as the execution of the Principal 
Transaction or Riskless Principal Transaction, the Financial 
Institution clearly and prominently:
    (1) Sets forth in writing (i) the circumstances under which the 
Adviser and Financial Institution may engage in Principal Transactions 
and Riskless Principal Transactions with the Plan, participant or 
beneficiary account, or IRA, (ii) a description of the types of 
compensation that may be received by the Adviser and Financial 
Institution in connection with Principal Transactions and Riskless 
Principal Transactions, including any types of compensation that may be 
received from third parties, and (iii) identifies and discloses the 
Material Conflicts of Interest associated with Principal Transactions 
and Riskless Principal Transactions;
    (2) Except for Existing Contracts, documents the Retirement 
Investor's affirmative written consent, on a prospective basis, to 
Principal Transactions and Riskless Principal Transactions between the 
Adviser or Financial Institution and the Plan, participant or 
beneficiary account, or IRA;
    (3) Informs the Retirement Investor (i) that the consent set forth 
in Section II(e)(2) is terminable at will upon written notice by the 
Retirement Investor at any time, without penalty to the Plan or IRA, 
(ii) of the right to obtain, free of charge, copies of the Financial 
Institution's written description of its policies and procedures 
adopted in accordance with Section II(d), as well as information about 
the Principal Traded Asset, including its purchase or sales price, and 
other salient attributes, including, as applicable: The credit quality 
of the issuer; the effective yield; the call provisions; and the 
duration, provided that if the Retirement Investor's request is made 
prior to the transaction, the information must be provided prior to the 
transaction, and if the request is made after the transaction, the 
information must be provided within 30 business days after the request, 
(iii) that model contract disclosures or other model notice of the 
contractual terms which are reviewed for accuracy no less than 
quarterly and updated within 30 days as necessary are maintained on the 
Financial Institution's Web site, and (iv) that the Financial 
Institution's written description of its policies and procedures 
adopted in accordance with Section II(d) is available free of charge on 
the Financial Institution's Web site; and
    (4) Describes whether or not the Adviser and Financial Institution 
will monitor the Retirement Investor's investments that are acquired 
through Principal Transactions and Riskless Principal Transactions and 
alert the Retirement Investor to any recommended change to those 
investments and, if so, the frequency with which the monitoring will 
occur and the reasons for which the Retirement Investor will be 
alerted.
    (5) The Financial Institution will not fail to satisfy this Section 
II(e), or violate a contractual provision based thereon, solely because 
it, acting in good faith and with reasonable diligence, makes an error 
or omission in disclosing the required information, or if the Web site 
is temporarily inaccessible, provided that (i) in the case of an error 
or omission on the web, the Financial Institution discloses the correct 
information as soon as practicable, but not later than 7 days after the 
date on which it discovers or reasonably should have discovered the 
error or omission, and (ii) in the case of other disclosures, the 
Financial Institution discloses the correct information as soon as 
practicable, but not later than 30 days after the date on which it 
discovers or reasonably should have discovered the error or omission. 
To the extent compliance with this requires Advisers and Financial 
Institutions to obtain information from entities that are not closely 
affiliated with them, they may rely in good faith on information and 
assurances from the other entities, as long as they do not know that 
the materials are incomplete or inaccurate. This good faith reliance 
applies unless the entity providing the information to the Adviser and 
Financial Institution is (1) a person directly or indirectly through 
one or more intermediaries, controlling, controlled by, or under common 
control with the Adviser or Financial Institution; or (2) any officer, 
director, employee, agent, registered representative, relative (as 
defined in ERISA section 3(15)), member of family (as defined in Code 
section 4975(e)(6)) of, or partner in, the Adviser or Financial 
Institution.
    (f) Ineligible Contractual Provisions. Relief is not available 
under the exemption if a Financial Institution's contract contains the 
following:
    (1) Exculpatory provisions disclaiming or otherwise limiting 
liability of the Adviser or Financial Institution for a violation of 
the contract's terms;
    (2) Except as provided in paragraph (f)(4) of this section, a 
provision under which the Plan, IRA or the Retirement Investor waives 
or qualifies its right to bring or participate in a class action or 
other representative action in court in a dispute with the Adviser or 
Financial Institution, or in an individual or class claim agrees to an 
amount representing liquidated damages for breach of the contract; 
provided that, the parties may knowingly agree to waive the Retirement 
Investor's right to obtain punitive damages or rescission of 
recommended transactions to the extent such a waiver is permissible 
under applicable state or federal law; or
    (3) Agreements to arbitrate or mediate individual claims in venues 
that are distant or that otherwise unreasonably limit the ability of 
the Retirement

[[Page 21136]]

Investors to assert the claims safeguarded by this exemption.
    (4) In the event provision on pre-dispute arbitration agreements 
for class or representative claims in paragraph (f)(2) of this section 
is ruled invalid by a court of competent jurisdiction, this provision 
shall not be a condition of this exemption with respect to contracts 
subject to the court's jurisdiction unless and until the court's 
decision is reversed, but all other terms of the exemption shall remain 
in effect.
    (g) ERISA Plans. For recommendations to Retirement Investors 
regarding Principal Transactions and Riskless Principal Transactions 
with Plans that are covered by Title I of ERISA, relief under the 
exemption is conditioned upon the Adviser and Financial Institution 
complying with certain provisions of Section II, as follows:
    (1) Prior to or at the same time as the execution of the Principal 
Transaction or Riskless Principal Transaction, the Financial 
Institution provides the Retirement Investor with a written statement 
of the Financial Institution's and its Advisers' fiduciary status, in 
accordance with Section II(b).
    (2) The Financial Institution and the Adviser comply with the 
Impartial Conduct Standards of Section II(c).
    (3) The Financial Institution adopts policies and procedures 
incorporating the requirements and prohibitions set forth in Section 
II(d)(1)-(4), and the Financial Institution and Adviser comply with 
those requirements and prohibitions.
    (4) The Financial Institution provides the disclosures required by 
Section II(e).
    (5) The Financial Institution and Adviser do not in any contract, 
instrument, or communication purport to disclaim any responsibility or 
liability for any responsibility, obligation, or duty under Title I of 
ERISA to the extent the disclaimer would be prohibited by ERISA section 
410, waive or qualify the right of the Retirement Investor to bring or 
participate in a class action or other representative action in court 
in a dispute with the Adviser or Financial Institution, or require 
arbitration or mediation of individual claims in locations that are 
distant or that otherwise unreasonably limit the ability of the 
Retirement Investors to assert the claims safeguarded by this 
exemption.

Section III--General Conditions

    The Adviser and Financial Institution must satisfy the following 
conditions to be covered by this exemption:
    (a) Debt Security Conditions. Solely with respect to the purchase 
of a Debt Security by a Plan, participant or beneficiary account, or 
IRA:
    (1) The Debt Security being purchased was not issued by the 
Financial Institution or any Affiliate;
    (2) The Debt Security being purchased is not purchased by the Plan, 
participant or beneficiary account, or IRA in an underwriting or 
underwriting syndicate in which the Financial Institution or any 
Affiliate is an underwriter or a member;
    (3) Using information reasonably available to the Adviser at the 
time of the transaction, the Adviser determines that the Debt Security 
being purchased:
    (i) Possesses no greater than a moderate credit risk; and
    (ii) Is sufficiently liquid that the Debt Security could be sold at 
or near its carrying value within a reasonably short period of time.
    (b) Arrangement. The Principal Transaction or Riskless Principal 
Transaction is not part of an agreement, arrangement, or understanding 
designed to evade compliance with ERISA or the Code, or to otherwise 
impact the value of the Principal Traded Asset.
    (c) Cash. The purchase or sale of the Principal Traded Asset is for 
cash.

Section IV--Disclosure Requirements

    This section sets forth the Adviser's and the Financial 
Institution's disclosure obligations to the Retirement Investor.
    (a) Pre-Transaction Disclosure. Prior to or at the same time as the 
execution of the Principal Transaction or Riskless Principal 
Transaction, the Adviser or the Financial Institution informs the 
Retirement Investor, orally or in writing, of the capacity in which the 
Financial Institution may act with respect to such transaction.
    (b) Confirmation. The Adviser or the Financial Institution provides 
a written confirmation of the Principal Transaction or Riskless 
Principal Transaction. This requirement may be satisfied by compliance 
with Rule 10b-10 under the Securities Exchange Act of 1934, or any 
successor rule in effect in effect at the time of the transaction, or 
for Advisers and Financial Institutions not subject to the Securities 
Exchange Act of 1934, similar requirements imposed by another regulator 
or self-regulatory organization.
    (c) Annual Disclosure. The Adviser or the Financial Institution 
sends to the Retirement Investor, no less frequently than annually, 
written disclosure in a single disclosure:
    (1) A list identifying each Principal Transaction and Riskless 
Principal Transaction executed in the Retirement Investor's account in 
reliance on this exemption during the applicable period and the date 
and price at which the transaction occurred; and
    (2) A statement that (i) the consent required pursuant to Section 
II(e)(2) is terminable at will upon written notice, without penalty to 
the Plan or IRA, (ii) the right of a Retirement Investor in accordance 
with Section II(e)(3)(ii) to obtain, free of charge, information about 
the Principal Traded Asset, including its salient attributes, (iii) 
model contract disclosures or other model notice of the contractual 
terms, which are reviewed for accuracy no less frequently than 
quarterly and updated within 30 days if necessary, are maintained on 
the Financial Institution's Web site, and (iv) the Financial 
Institution's written description of its policies and procedures 
adopted in accordance with Section II(d) are available free of charge 
on the Financial Institution's Web site.
    (d) The Financial Institution will not fail to satisfy this Section 
IV solely because it, acting in good faith and with reasonable 
diligence, makes an error or omission in disclosing the required 
information, or if the Web site is temporarily inaccessible, provided 
that (i) in the case of an error or omission on the web, the Financial 
Institution discloses the correct information as soon as practicable, 
but not later than 7 days after the date on which it discovers or 
reasonably should have discovered the error or omission, and (ii) in 
the case of other disclosures, the Financial Institution discloses the 
correct information as soon as practicable, but not later than 30 days 
after the date on which it discovers or reasonably should have 
discovered the error or omission. To the extent compliance with the 
disclosure requires Advisers and Financial Institutions to obtain 
information from entities that are not closely affiliated with them, 
the exemption provides that they may rely in good faith on information 
and assurances from the other entities, as long as they do not know 
that the materials are incomplete or inaccurate. This good faith 
reliance applies unless the entity providing the information to the 
Adviser and Financial Institution is (1) a person directly or 
indirectly through one or more intermediaries, controlling, controlled 
by, or under common control with the Adviser or Financial Institution; 
or (2) any officer, director, employee, agent, registered 
representative, relative (as defined in ERISA section 3(15)), member of 
family (as defined in Code section 4975(e)(6)) of, or partner in, the 
Adviser or Financial Institution.
    (e) The Financial Institution prepares a written description of its 
policies and

[[Page 21137]]

procedures and makes it available on its Web site and additionally, to 
Retirement Investors, free of charge, upon request. The description 
must accurately describe or summarize key components of the policies 
and procedures relating to conflict-mitigation and incentive practices 
in a manner that permits Retirement Investors to make an informed 
judgment about the stringency of the Financial Institution's 
protections against conflicts of interest. Additionally, Financial 
Institutions must provide their complete policies and procedures to the 
Department upon request.

Section V--Recordkeeping

    This section establishes record retention and availability 
requirements that a Financial Institution must meet in order for it to 
rely on the exemption.
    (a) The Financial Institution maintains for a period of six (6) 
years from the date of each Principal Transaction or Riskless Principal 
Transaction, in a manner that is reasonably accessible for examination, 
the records necessary to enable the persons described in Section V(b) 
to determine whether the conditions of this exemption have been met, 
except that:
    (1) If such records are lost or destroyed, due to circumstances 
beyond the control of the Financial Institution, then no prohibited 
transaction will be considered to have occurred solely on the basis of 
the unavailability of those records; and
    (2) No party other than the Financial Institution that is engaging 
in the Principal Transaction or Riskless Principal Transaction shall be 
subject to the civil penalty that may be assessed under ERISA section 
502(i) or to the taxes imposed by Code sections 4975(a) and (b) if the 
records are not maintained or are not available for examination as 
required by Section V(b).
    (b)(1) Except as provided in Section V(b)(2) or as precluded by 12 
U.S.C. 484, and notwithstanding any provisions of ERISA sections 
504(a)(2) and 504(b), the records referred to in Section V(a) are 
reasonably available at their customary location for examination during 
normal business hours by:
    (i) Any duly authorized employee or representative of the 
Department or the Internal Revenue Service;
    (ii) any fiduciary of the Plan or IRA that was a party to a 
Principal Transaction or Riskless Principal Transaction described in 
this exemption, or any duly authorized employee or representative of 
such fiduciary;
    (iii) any employer of participants and beneficiaries and any 
employee organization whose members are covered by the Plan, or any 
authorized employee or representative of these entities; and
    (iv) any participant or beneficiary of the Plan, or the beneficial 
owner of an IRA.
    (2) None of the persons described in subparagraph (1)(ii) through 
(iv) are authorized to examine records regarding a Prohibited 
Transaction involving another Retirement Investor, or trade secrets of 
the Financial Institution, or commercial or financial information which 
is privileged or confidential; and
    (3) Should the Financial Institution refuse to disclose information 
on the basis that such information is exempt from disclosure, the 
Financial Institution must by the close of the thirtieth (30th) day 
following the request, provide a written notice advising the requestor 
of the reasons for the refusal and that the Department may request such 
information.
    (4) Failure to maintain the required records necessary to determine 
whether the conditions of this exemption have been met will result in 
the loss of the exemption only for the transaction or transactions for 
which records are missing or have not been maintained. It does not 
affect the relief for other transactions.

Section VI--Definitions

    For purposes of this exemption:
    (a) ``Adviser'' means an individual who:
    (1) Is a fiduciary of a Plan or IRA solely by reason of the 
provision of investment advice described in ERISA section 3(21)(A)(ii) 
or Code section 4975(e)(3)(B), or both, and the applicable regulations, 
with respect to the Assets involved in the transaction;
    (2) Is an employee, independent contractor, agent, or registered 
representative of a Financial Institution; and
    (3) Satisfies the applicable federal and state regulatory and 
licensing requirements of banking, and securities laws with respect to 
the covered transaction.
    (b) ``Affiliate'' of an Adviser or Financial Institution means:
    (1) Any person directly or indirectly, through one or more 
intermediaries, controlling, controlled by, or under common control 
with the Adviser or Financial Institution. For this purpose, the term 
``control'' means the power to exercise a controlling influence over 
the management or policies of a person other than an individual;
    (2) Any officer, director, partner, employee, or relative (as 
defined in ERISA section 3(15)) of the Adviser or Financial 
Institution; or
    (3) Any corporation or partnership of which the Adviser or 
Financial Institution is an officer, director, or partner of the 
Adviser or Financial Institution.
    (c) Investment advice is in the ``Best Interest'' of the Retirement 
Investor when the Adviser and Financial Institution providing the 
advice act with the care, skill, prudence, and diligence under the 
circumstances then prevailing that a prudent person acting in a like 
capacity and familiar with such matters would use in the conduct of an 
enterprise of a like character and with like aims, based on the 
investment objectives, risk tolerance, financial circumstances, and 
needs of the Retirement Investor, without regard to the financial or 
other interests of the Adviser, Financial Institution, any Affiliate or 
other party.
    (d) ``Debt Security'' means a ``debt security'' as defined in Rule 
10b-10(d)(4) of the Exchange Act that is:
    (1) U.S. dollar denominated, issued by a U.S. corporation and 
offered pursuant to a registration statement under the Securities Act 
of 1933;
    (2) An ``Agency Debt Security'' as defined in FINRA rule 6710(l) or 
its successor;
    (3) An ``Asset Backed Security'' as defined in FINRA rule 6710(m) 
or its successor, that is guaranteed by an Agency as defined in FINRA 
rule 6710(k) or its successor, or a Government Sponsored Enterprise as 
defined in FINRA rule 6710(n) or its successor; or
    (4) A ``U.S. Treasury Security'' as defined in FINRA rule 6710(p) 
or its successor.
    (e) ``Financial Institution'' means the entity that (i) employs the 
Adviser or otherwise retains such individual as an independent 
contractor, agent or registered representative, and (ii) customarily 
purchases or sells Principal Traded Assets for its own account in the 
ordinary course of its business, and that is:
    (1) Registered as an investment adviser under the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.) or under the laws of the 
state in which the adviser maintains its principal office and place of 
business;
    (2) A bank or similar financial institution supervised by the 
United States or state, or a savings association (as defined in section 
3(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1813(b)(1))); 
and

[[Page 21138]]

    (3) A broker or dealer registered under the Securities Exchange Act 
of 1934 (15 U.S.C. 78a et seq.).
    (f) ``Independent'' means a person that:
    (1) Is not the Adviser or Financial Institution or an Affiliate;
    (2) Does not receive or is not projected to receive within the 
current federal income tax year, compensation or other consideration 
for his or her own account from the Adviser, Financial Institution or 
an Affiliate in excess of 2% of the person's annual revenues based upon 
its prior income tax year; and
    (3) Does not have a relationship to or an interest in the Adviser, 
Financial Institution or an Affiliate that might affect the exercise of 
the person's best judgment in connection with transactions described in 
this exemption.
    (g) ``Individual Retirement Account'' or ``IRA'' means any account 
or annuity described in Code section 4975(e)(1)(B) through (F), 
including, for example, an individual retirement account described in 
Code section 408(a) and a health savings account described in Code 
section 223(d).
    (h) A ``Material Conflict of Interest'' exists when an Adviser or 
Financial Institution has a financial interest that a reasonable person 
would conclude could affect the exercise of its best judgment as a 
fiduciary in rendering advice to a Retirement Investor.
    (i) ``Plan'' means an employee benefit plan described in ERISA 
section 3(3) and any plan described in Code section 4975(e)(1)(A).
    (j) ``Principal Traded Asset'' means:
    (1) For purposes of a purchase by a Plan, participant or 
beneficiary account, or IRA,
    (i) a Debt Security, as defined in subsection (d) above;
    (ii) a certificate of deposit (CD);
    (iii) an interest in a Unit Investment Trust, within the meaning of 
Section 4(2) of the Investment Company Act of 1940, as amended; or
    (iv) an investment that is permitted to be purchased under an 
individual exemption granted by the Department under ERISA section 
408(a) and/or Code section 4975(c), after the effective date of this 
exemption, that provides relief for investment advice fiduciaries to 
engage in the purchase of the investment in a Principal Transaction or 
a Riskless Principal Transaction with a Plan or IRA under the same 
conditions as this exemption; and
    (2) for purposes of a sale by a Plan, participant or beneficiary 
account, or IRA, securities or other investment property.
    (k) ``Principal Transaction'' means a purchase or sale of a 
Principal Traded Asset in which an Adviser or Financial Institution is 
purchasing from or selling to a Plan, participant or beneficiary 
account, or IRA on behalf of the Financial Institution's own account or 
the account of a person directly or indirectly, through one or more 
intermediaries, controlling, controlled by, or under common control 
with the Financial Institution. For purposes of this definition, a 
Principal Transaction does not include a Riskless Principal Transaction 
as defined in Section VI(m).
    (l) ``Retirement Investor'' means:
    (1) A fiduciary of a non-participant directed Plan subject to Title 
I of ERISA or described in Code section 4975(c)(1)(A) with authority to 
make investment decisions for the Plan;
    (2) A participant or beneficiary of a Plan subject to Title I of 
ERISA or described in Code section 4975(c)(1)(A) with authority to 
direct the investment of assets in his or her Plan account or to take a 
distribution; or
    (3) The beneficial owner of an IRA acting on behalf of the IRA.
    (m) ``Riskless Principal Transaction'' means a transaction in which 
a Financial Institution, after having received an order from a 
Retirement Investor to buy or sell a Principal Traded Asset, purchases 
or sells the asset for the Financial Institution's own account to 
offset the contemporaneous transaction with the Retirement Investor.

Section VII--Transition Period for Exemption

    (a) In general. ERISA and the Internal Revenue Code prohibit 
fiduciary advisers to employee benefit plans (Plans) and individual 
retirement plans (IRAs) from receiving compensation that varies based 
on their investment recommendations. ERISA and the Code also prohibit 
fiduciaries from engaging in securities purchases and sales with Plans 
or IRAs on behalf of their own accounts (Principal Transactions). This 
transition period provides relief from the restrictions of ERISA 
section 406(a)(1)(A) and (D) and section 406(b)(1) and (2), and the 
taxes imposed by Code section 4975(a) and (b), by reason of Code 
section 4975(c)(1)(A), (D), and (E) for the period from April 10, 2017, 
to January 1, 2018 (the Transition Period) for Advisers and Financial 
Institutions to engage in certain Principal Transactions and Riskless 
Principal Transactions with Plans and IRAs subject to the conditions 
described in Section VII(d).
    (b) Covered transactions. This provision permits an Adviser or 
Financial Institution to engage in the purchase or sale of a Principal 
Traded Asset in a Principal Transaction or a Riskless Principal 
Transaction with a Plan, participant or beneficiary account, or IRA, 
and receive a mark-up, mark-down or other similar payment as applicable 
to the transaction for themselves or any Affiliate, as a result of the 
Adviser's and Financial Institution's advice regarding the Principal 
Transaction or the Riskless Principal Transaction, during the 
Transition Period.
    (c) Exclusions. This provision does not apply if:
    (1) The Adviser: (i) Has or exercises any discretionary authority 
or discretionary control respecting management of the assets of the 
Plan or IRA involved in the transaction or exercises any discretionary 
authority or control respecting management or the disposition of the 
assets; or (ii) has any discretionary authority or discretionary 
responsibility in the administration of the Plan or IRA; or
    (2) The Plan is covered by Title I of ERISA, and (i) the Adviser, 
Financial Institution or any Affiliate is the employer of employees 
covered by the Plan, or (ii) the Adviser or Financial Institution is a 
named fiduciary or plan administrator (as defined in ERISA section 
3(16)(A)) with respect to the Plan, or an Affiliate thereof, that was 
selected to provide advice to the Plan by a fiduciary who is not 
Independent;
    (d) Conditions. The provision is subject to the following 
conditions:
    (1) The Financial Institution and Adviser adhere to the following 
standards:
    (i) When providing investment advice to the Retirement Investor 
regarding the Principal Transaction or Riskless Principal Transaction, 
the Financial Institution and the Adviser(s) provide investment advice 
that is, at the time of the recommendation, in the Best Interest of the 
Retirement Investor. As further defined in Section VI(c), such advice 
reflects the care, skill, prudence, and diligence under the 
circumstances then prevailing that a prudent person acting in a like 
capacity and familiar with such matters would use in the conduct of an 
enterprise of a like character and with like aims, based on the 
investment objectives, risk tolerance, financial circumstances, and 
needs of the Retirement Investor, without regard to the financial or 
other interests of the Adviser, Financial Institution or any Affiliate 
or other party;
    (ii) The Adviser and Financial Institution will seek to obtain the 
best execution reasonably available under the circumstances with 
respect to the

[[Page 21139]]

Principal Transaction or Riskless Principal Transaction. Financial 
Institutions that are FINRA members shall satisfy this requirement if 
they comply with the terms of FINRA rules 2121 (Fair Prices and 
Commissions) and 5310 (Best Execution and Interpositioning), or any 
successor rules in effect at the time of the transaction, as 
interpreted by FINRA, with respect to the Principal Transaction or 
Riskless Principal Transaction; and
    (iii) Statements by the Financial Institution and its Advisers to 
the Retirement Investor about the Principal Transaction or Riskless 
Principal Transaction, fees and compensation related to the Principal 
Transaction or Riskless Principal Transaction, Material Conflicts of 
Interest, and any other matters relevant to a Retirement Investor's 
decision to engage in the Principal Transaction or Riskless Principal 
Transaction, are not materially misleading at the time they are made.
    (2) Disclosures. The Financial Institution provides to the 
Retirement Investor, prior to or at the same time as the execution of 
the recommended Principal Transaction or Riskless Principal 
Transaction, a single written disclosure, which may cover multiple 
transactions or all transactions occurring within the Transition 
Period, that clearly and prominently:
    (i) Affirmatively states that the Financial Institution and the 
Adviser(s) act as fiduciaries under ERISA or the Code, or both, with 
respect to the recommendation;
    (ii) Sets forth the standards in paragraph (d)(1) of this section 
and affirmatively states that it and the Adviser(s) adhered to such 
standards in recommending the transaction; and
    (iii) Discloses the circumstances under which the Adviser and 
Financial Institution may engage in Principal Transactions and Riskless 
Principal Transactions with the Plan, participant or beneficiary 
account, or IRA, and identifies and discloses the Material Conflicts of 
Interest associated with Principal Transactions and Riskless Principal 
Transactions.
    (iv) The disclosure may be provided in person, electronically or by 
mail. It does not have to be repeated for any subsequent 
recommendations during the Transition Period.
    (v) The Financial Institution will not fail to satisfy this Section 
VII(d)(2) solely because it, acting in good faith and with reasonable 
diligence, makes an error or omission in disclosing the required 
information, provided the Financial Institution discloses the correct 
information as soon as practicable, but not later than 30 days after 
the date on which it discovers or reasonably should have discovered the 
error or omission. To the extent compliance with this Section VII(d)(2) 
requires Advisers and Financial Institutions to obtain information from 
entities that are not closely affiliated with them, they may rely in 
good faith on information and assurances from the other entities, as 
long as they do not know, or unless they should have known, that the 
materials are incomplete or inaccurate. This good faith reliance 
applies unless the entity providing the information to the Adviser and 
Financial Institution is (1) a person directly or indirectly through 
one or more intermediaries, controlling, controlled by, or under common 
control with the Adviser or Financial Institution; or (2) any officer, 
director, employee, agent, registered representative, relative (as 
defined in ERISA section 3(15)), member of family (as defined in Code 
section 4975(e)(6)) of, or partner in, the Adviser or Financial 
Institution.
    (3) The Financial Institution must designate a person or persons, 
identified by name, title or function, responsible for addressing 
Material Conflicts of Interest and monitoring Advisers' adherence to 
the Impartial Conduct Standards.
    (4) The Financial Institution complies with the recordkeeping 
requirements of Section V(a) and (b).

    Signed at Washington, DC, this 1st day of April, 2016.
Phyllis C. Borzi,
Assistant Secretary, Employee Benefits Security Administration, 
Department of Labor.
[FR Doc. 2016-07926 Filed 4-6-16; 11:15 am]
 BILLING CODE 4510-29-P